[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]

                         CREDIT-BASED INSURANCE
                         SCORES: ARE THEY FAIR?



                               BEFORE THE

                            SUBCOMMITTEE ON

                                 OF THE


                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION


                            OCTOBER 2, 2007


       Printed for the use of the Committee on Financial Services

                           Serial No. 110-64

39-902                      WASHINGTON : 2008
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                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            RICHARD H. BAKER, Louisiana
LUIS V. GUTIERREZ, Illinois          MICHAEL N. CASTLE, Delaware
NYDIA M. VELAZQUEZ, New York         PETER T. KING, New York
MELVIN L. WATT, North Carolina       EDWARD R. ROYCE, California
GARY L. ACKERMAN, New York           FRANK D. LUCAS, Oklahoma
JULIA CARSON, Indiana                RON PAUL, Texas
BRAD SHERMAN, California             PAUL E. GILLMOR, Ohio
DENNIS MOORE, Kansas                 DONALD A. MANZULLO, Illinois
MICHAEL E. CAPUANO, Massachusetts    WALTER B. JONES, Jr., North 
RUBEN HINOJOSA, Texas                    Carolina
WM. LACY CLAY, Missouri              JUDY BIGGERT, Illinois
CAROLYN McCARTHY, New York           CHRISTOPHER SHAYS, Connecticut
JOE BACA, California                 GARY G. MILLER, California
BRAD MILLER, North Carolina              Virginia
DAVID SCOTT, Georgia                 TOM FEENEY, Florida
AL GREEN, Texas                      JEB HENSARLING, Texas
EMANUEL CLEAVER, Missouri            SCOTT GARRETT, New Jersey
MELISSA L. BEAN, Illinois            GINNY BROWN-WAITE, Florida
GWEN MOORE, Wisconsin,               J. GRESHAM BARRETT, South Carolina
LINCOLN DAVIS, Tennessee             JIM GERLACH, Pennsylvania
ALBIO SIRES, New Jersey              STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES A. WILSON, Ohio              JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida               KENNY MARCHANT, Texas
JIM MARSHALL, Georgia                THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
              Subcommittee on Oversight and Investigations

                MELVIN L. WATT, North Carolina, Chairman

LUIS V. GUTIERREZ, Illinois          GARY G. MILLER, California
MAXINE WATERS, California            PATRICK T. McHENRY, North Carolina
STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         RON PAUL, Texas
CAROLYN McCARTHY, New York           J. GRESHAM BARRETT, South Carolina
RON KLEIN, Florida                   TOM PRICE, Georgia
TIM MAHONEY, Florida                 MICHELE BACHMANN, Minnesota
ROBERT WEXLER, Florida               PETER J. ROSKAM, Illinois

                            C O N T E N T S

Hearing held on:
    October 2, 2007..............................................     1
    October 2, 2007..............................................    37

                        Tuesday, October 2, 2007

Birnbaum, Birny, Executive Director, Center for Economic Justice.    13
Kreidler, Hon. Mike, Commissioner of Insurance, State of 
  Washington.....................................................    11
Rodriguez, Eric, Deputy Vice President, National Council of 
  LaRaza.........................................................    15
Rosch, Hon. J. Thomas, Commissioner, Federal Trade Commission....     7
Schmidt, Hon. J.P., Commissioner of Insurance, State of Hawaii...     9
Shapo, Nathaniel, Partner, Katten Muchin Rosenman, LLP...........    17


Prepared statements:
    Watt, Hon. Melvin L..........................................    38
    Waters, Hon. Maxine..........................................    44
    Birnbaum, Birny..............................................    47
    Kreidler, Hon. Mike..........................................    79
    Rodriguez, Eric..............................................   101
    Rosch, Hon. J. Thomas........................................   109
    Schmidt, Hon. J.P............................................   152
    Shapo, Nathaniel.............................................   155

              Additional Material Submitted for the Record

Watt, Hon. Melvin L.:
    Report on Washington State bill ESHB 2544....................   166
    State of Washington, Office of Insurance Commissioner, ``A 
      Report to the Legislature: Insurance Credit Scoring''......   171
    Letter from Hon. Barney Frank, Hon. Melvin L. Watt, and Hon. 
      Luis V. Gutierrez to the Federal Trade Commission, dated 
      August 28, 2007............................................   202
    Response letter from the Federal Trade Commission to Hon. 
      Barney Frank, dated September 17, 2007.....................   205
    Statement of various consumer groups.........................   214
    Letter from the National Conference of Insurance Legislators 
      (NCOIL)....................................................   217
    Letter from the Hispanic Alliance for Progress Institute.....   219
    Statement of the American Insurance Association, the National 
      Association of Mutual Insurance Companies, and the Property 
      Casualty Insurers Association of America...................   221
    Response of Eric Rodriguez to questions submitted for the 
      record.....................................................   225
    Response of J. Thomas Rosch to questions submitted for the 
      record.....................................................   228
    Response of J.P. Schmidt to questions submitted for the 
      record.....................................................   232
    Response of Nathaniel Shapo to questions submitted for the 
      record.....................................................   235
    Response of Mike Kreidler to questions submitted for the 
      record.....................................................   239

                         CREDIT-BASED INSURANCE
                         SCORES: ARE THEY FAIR?


                        Tuesday, October 2, 2007

             U.S. House of Representatives,
                          Subcommittee on Oversight
                                and Investigations,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 2:02 p.m., in 
room 2128, Rayburn House Office Building, Hon. Melvin L. Watt 
[chairman of the subcommittee] presiding.
    Members present: Representatives Watt, Waters, Klein; 
Miller, Price, and Roskam.
    Chairman Watt. This hearing of the Subcommittee on 
Oversight and Investigations will come to order. Without 
objection, all members' opening statements will be made a part 
of the record, and I will now recognize myself for an opening 
    Credit-based insurance scores are numerical summaries of 
the credit histories of consumers. The scores are calculated 
using information contained in a consumer report, information 
such as past delinquencies, consumer debt ratios, and the 
length of credit. The use of credit-based insurance scores has 
increased rapidly during the 1990's and today credit-based 
insurance scores are widely used.
    While common sense tells you that speeding tickets, driving 
under the influence of drugs and alcohol, or automobile 
accidents should increase automobile insurance premiums, most 
Americans would probably be surprised to learn that late 
payments on credit cards can dramatically increase the premiums 
they pay for automobile insurance. In other words, one's credit 
history, not one's driving history, is likely to be 
determinative of the cost of one's automobile insurance. That 
might be the equivalent to having your driving history 
determine whether you get a bank loan or determine the interest 
rate you will pay on your bank loan.
    The question we need to address is whether this is fair. 
Today's hearing is entitled, ``Credit-based Insurance Scores: 
Are They Fair?'' Our objective is to shed light on the growing 
but often hidden use of credit information in the pricing and 
underwriting of insurance and to start analyzing, discussing, 
and determining whether that is fair or whether it even makes 
    A number of consumer and civil rights groups and some 
States say that it's not fair. They argue that these scores are 
used to raise premiums, deny coverage for new customers, and 
deny renewals of existing insurance policies, even in the 
absence of common-sense risk factors, such as moving violations 
or accidents. They say that the use of credit-based insurance 
scores disproportionately hurts young people and minorities. 
Some States have already enacted laws or adopted regulations 
that either ban or restrict the use of credit-based insurance 
scores. For example two of our witnesses today represent 
States, Hawaii and Washington, that limit or ban the 
consideration of credit-based insurance scores in underwriting 
automobile insurance.
    We look forward to their testimony, and I think you will 
find it interesting. I've reviewed, for example, the 
legislative history for the Washington State law and find this 
interesting quote in their legislative history:
    ``There have been hundreds of complaints filed in the OIC 
regarding insurance companies' use of credit scoring for use of 
underwriting and rate-setting purposes. For example, one woman 
who paid her premiums and never had an accident was told that 
her premiums went up because her credit rating was bad due to a 
period of unemployment. A woman who had her insurance premium 
rates increase by 46 percent, even though she paid all her 
premiums on time, discovered that her credit score was low due 
to a bankruptcy filed by her ex-husband. A couple was denied 
access to reasonable rates because they paid all their bills in 
cash, and therefore had no credit history. There are many 
reasons for a low credit score that do not take into account 
individual circumstances or creditworthiness.''
    That is from the legislative history of the Washington 
    The first Federal study on credit-based insurance scores 
was recently released by the Federal Trade Commission. The FTC 
was directed under Section 215 of the Fact Act to study whether 
the use of credit-based insurance scores ``could result in 
negative or differential treatment of protected classes under 
the Equal Credit Opportunity Act and whether such underwriting 
systems could achieve comparable results through the use of 
factors with less negative impact.''
    The FTC study grew out of a compromise between the prospect 
of an outright Federal ban on the use of credit-based insurance 
scoring, on the one hand, and doing nothing, on the other hand, 
and I would note that neither one of the two--both of the 
members who were responsible for the study are on this 
committee: the chairman, who orchestrated the study, and is 
opposed an outright ban; and Representative Gutierrez, whom I 
hope will show up here at some point during the course of this 
hearing because he is on the subcommittee.
    The first FTC report focused exclusively on automobile 
insurance, and while it concluded that credit-based insurance 
scores are ``effective predictors of risks,'' it also found 
that in three out of four lines of automobile insurance there 
is ``some'' proxy effect based upon race. While the FTC didn't 
get to this latter finding until page 69 of the report, I 
believe that any finding of a proxy effect, however small, 
should be cause for concern in this day and age.
    Several concerns have been raised about the reliability and 
validity of the FTC's report. One FTC Commissioner dissented 
from the report, noting disagreement with the methodology used 
to generate the underlying data used in the report because it 
relied solely on data the insurance industry voluntarily 
submitted and on publicly available data. The dissent suggested 
that the FTC could have served insurance companies with Section 
6(b) orders to obtain a ``more accurate and complete dataset, 
which would have provided a strong foundation for staff's 
complex economic analysis.''
    Even with perceived shortcomings of the data, the FTC 
report still concluded that there was some proxy effect from 
the use of credit-based insurance scores in three out of four 
lines of automobile insurance. As the dissenting Commissioner 
noted, the study ``still found that credit-based insurance 
scores have a small effect as a proxy for membership in racial 
and ethnic groups. Given the incompleteness of the data, it is 
unclear whether the actual proxy effect might be greater.'' 
Another Commissioner's concurring statement to the report 
conceived that ``the results in today's report are no cause for 
celebration,'' referring to the difference in credit-based 
insurance scores across racial and ethnic groups. In short the 
FTC's report, the one on automobile insurance that we are 
considering today, may raise more questions than it answers, 
especially about whether the use of credit-based insurance 
scoring disproportionately impacts minorities.
    The FTC is preparing a second report on the impact on using 
credit-based insurance scoring on homeowner's insurance. Given 
the serious concerns raised about the validity of the data for 
the automobile insurance report and the critical importance of 
the second report on homeowner's insurance, Chairman Frank, 
Representative Gutierrez, and I have requested the FTC to 
consider using its more extensive authority for the homeowner's 
study to obtain a large and statistically valid dataset from 
    The FTC has advised us that this could take 2 to 3 years 
longer, and one of the things I'll be asking about today is 
whether this is likely to get a more reliable conclusion or 
whether it would just take 2 to 3 years more to get another 
study that probably would be perceived as just as unreliable.
    Due to the uncertain reliability of using credit-based 
insurance scores in setting insurance rates, we certainly must 
proceed with care. This hearing is the first step, certainly 
not the last, in the process of raising the important questions 
that need to be asked, and in educating ourselves, other 
Members of Congress, and the public about the critical 
importance of this issues.
    In the final analysis, I think it should be clear that 
neither the FTC report nor today's hearing should deter the 
States from their traditional role in regulating insurance. The 
fact that Hawaii and Illinois or Hawaii and Washington or 
Hawaii and North Carolina differ in their legislation and in 
their regulation of credit-based insurance scores is not 
necessarily a bad thing. States have historically regulated and 
controlled insurance, and have historically been the so-called 
``legislative and regulatory laboratories for innovation.'' 
State insurance regulators are the best-equipped to regulate 
insurance credit scoring and should continue to do so, 
certainly until we have a better understanding of the facts and 
the arguments for and against whether credit-based insurance 
scoring is fair.
    I will now recognize Ranking Member Miller for an opening 
    Mr. Miller of California. Thank you very much.
    I think it's important to recognize right off the bat that 
credit-based insurance scores are just one of the tools that 
insurance companies use to determine rates for the people they 
are insuring. It is not the only tool, and we need to highlight 
the fact that the States make the determination whether or not 
they are used and applied at the State level. The Federal 
Government does not do that.
    But over the years insurers have been using credit scores 
as an objective underwriting factor to evaluate insurance 
applications, especially for automobile and homeowner 
insurance, as a predictor of possible future insurance claims 
their customers might incur. After some questioned the 
legitimacy of this practice and expressed concerns that the 
screening method was discriminating against minorities, 
Congress directed the Federal Reserve Board and the Federal 
Trade Commission, the FTC, to study the effects of credit 
scoring on credit and insurance markets and report their 
findings back to Congress. The Fed's report evaluated credit 
markets and the FTC examined the use of credit scoring in 
establishing insurance prices.
    The FTC has recently published a portion of their study 
which closely examined the effects of credit-based insurance 
scores on the availability and affordability of automobile 
insurance. Expert economists at the FTC concluded that these 
scores are effective predictors of claims that consumers file, 
and that there is no evidence of credit score discrimination 
against any minority group. This conclusion was reached after 
the Commission reviewed almost 200 public comments, researched 
and evaluated data collected from a wide variety of sources, 
consulted with community, civil rights, consumers', and housing 
groups, government agencies, and private companies. In fact, 
their conclusion was similar to results formed after the Texas 
Department of Insurance studied the use of credit scores to 
assess automobile risks.
    Further the FTC concluded that credit scoring is not only 
valid, it is actually good for consumers. This study along with 
many other studies indicates that credit scoring is beneficial 
to consumers because it is one of the most accurate ways to 
gauge risk and price fairly. Consumers have power over their 
credit scores, and credit scores are one tool insurers have to 
better match an individual's risk with a suitable premium, 
which for consumers with good credit means lower premiums. 
Actually the FTC concluded that scores give insurers the 
opportunity to offer insurance to higher-risk consumers for 
whom they otherwise would not be able to determine an 
appropriate premium.
    The Feds also issued a report this summer on credit, which 
described credit scoring as likely increasing the consistency 
and objectivity of credit evaluation, and thus may help 
diminish the possibility that credit decisions will be 
influenced by personal characteristics or other factors 
prohibited by law, including race and ethnicity.
    The link between credit history and loss potential has also 
been frequently examined by academia. These studies show that 
consumers under stress are more likely to have auto accidents 
and financial problems. Studies have found that people with 
poor insurance scores are more likely to engage in risky 
behavior, and therefore are more likely to incur financial 
losses. Insurance appraisers evaluate their customers and price 
policies to ensure that consumers less likely to incur losses 
are not subsidizing those who are riskier and tend to have more 
auto accidents.
    Researchers indicated that if people take care of their 
finances, they are likely to exercise the same amount of 
responsibility in other aspects of their life. While it is 
unclear exactly why there is a correlation between credit 
scores and insurance losses, the relationship is proven to 
exist. It has been determined that drivers with bad credit 
histories are more likely to have repeated accidents than those 
with good credit history. With years of studies and research 
showing that there is a clear and consistent relationship, it 
seems it would be irresponsible for the insurance industry to 
ignore the predictive power of insurance credit scoring, and 
consumers less likely to incur losses would ultimately pay the 
    It seems to me that instead the Financial Services 
Committee should instead be examining ways to improve consumer 
credit reports through consumer finance education and the use 
of non-traditional credit providers, like utilities and phone 
companies, to report information to their customers.
    Once again, I think this is an appropriate hearing we're 
having today. We requested that these studies be prepared, and 
the studies were prepared. I know not everybody is going to 
like the results of the study, but the studies were very 
conclusive that using credit-based insurance scores were not 
discriminatory and that they were beneficial to individuals. 
And it was a predictor of basically the loss an insurance 
company might suffer, and therefore they could apply it in 
appropriate ways.
    I thank you and I yield back.
    Chairman Watt. I thank the gentleman. As I had previously 
indicated, opening statements of all members will be made a 
part of the record. Unless somebody's crying out to be heard, 
we will proceed.
    We have received a number of requests for submissions to 
the record, so let me get that dispensed with. I ask unanimous 
consent to submit the following written documents for the 
record: a copy of the House Bill Report on ESHB2544, that's 
Washington State's bill; the report to the legislature called 
``Insurance Credit Scoring'' from the State of Washington 
Office of the Insurance Commissioner; a letter from Chairman 
Barney Frank, Representative Gutierrez, and myself to the FTC 
about the process that was used and the process that will be 
used or may be used in their follow-up study--that letter is 
dated August 28, 2007; a response from the Federal Trade 
Commission dated September 17, 2007, giving us their response 
to our letter; a submission from a number of consumer groups, 
Consumer Federation of America, Fair Housing Alliance, Consumer 
Union, and others, dated October 2, 2007; a submission dated 
October 2, 2007, from the National Conference of Insurance 
Legislators; a submission dated October 1, 2007, from the 
Hispanic Alliance for Progress Institute; and a submission 
dated October 2, 2007, from the American Insurance Association, 
the National Association of Mutual Insurance Companies, and the 
Property Casualty Insurance Association of America. Without 
objection, those documents will be submitted for the record.
    We will now introduce this outstanding, distinguished panel 
of witnesses and try to get to them to do their testimony.
    The first witness we will hear from is Commissioner J. 
Thomas Rosch, who was sworn in as a Commissioner of the FTC on 
January 5, 2006, to a term that expires in September of 2012. 
He joined the FTC from the San Francisco law firm of Latham and 
Watkins, where he was formerly the managing partner. Mr. Rosch 
has served as chair of the ABA's Antitrust Section in 1990 and 
chair of the California Bar Association's antitrust section, 
and also served as the FTC's Director of the Bureau of Consumer 
Protection from 1973 to 1975. And he is nationally regarded for 
his antitrust and trade regulation law experience, has been 
lead counsel in over 100 Federal and State court antitrust 
cases, and in 2003, was honored as antitrust lawyer of the year 
by the California State Bar antitrust section. He obtained his 
law degree from Harvard in 1965.
    Our second witness will be Hawaii Insurance Commissioner J. 
P. Schmidt. Mr. Schmidt was appointed insurance commissioner of 
Hawaii in 2003. Previously, he was a partner in the law firm of 
Crockett, Nakamura, and Schmidt in Maui. In the 1990's, he was 
corporation counsel for the County of Maui. Before moving to 
Maui in 1989, he was an officer with a Los Angeles bank in 
commercial lending, and he received his J.D. degree from the 
University of California, Davis, and a B.A. degree in 
philosophy from U.C.L.A.
    The third witness is, I realized earlier today when I was 
reading the bios, my classmate and former colleague in 
Congress. We were both elected to Congress in 1992, and he is a 
living example that there is life after Congress. I keep trying 
to figure out whether that's true or not, but I think I'm 
convinced of that. He is Washington Insurance Commissioner Mike 
    Mike was elected insurance commissioner of Washington in 
2000. He is also a former Member of Congress where he served on 
the House Energy and Commerce Committee. He served in the 
Washington Legislature for 16 years, focusing on issues related 
to healthcare and the environment. As insurance commissioner, 
he was instrumental in studying the effect of credit-based 
insurance scores on consumers, and helped win passage in 2003 
of Washington's law limiting the use of credit-based insurance 
scores in personal lines of insurance. He earned a master's 
degree in public health from U.C.L.A. and a doctor of optometry 
from Pacific University in Oregon. He is a retired lieutenant 
colonel with 25 years of active and reserve service in the 
    Our fourth witness--I just want to give a special welcome 
to my former classmate here in Congress. Our fourth witness is 
Birny Birnbaum from the Center for Economic Justice. Mr. 
Birnbaum is a consulting economist and executive director of 
the Center for Economic Justice, an Austin, Texas-based non-
profit that advocates on behalf of consumers on insurance, 
credit, and utility matters. He has been working on insurance 
credit scoring since 1991 as both an insurance regulator, chief 
economist, and associate commissioner for policy and research 
at the Texas Department of Insurance, and as a consumer 
advocate. He has testified about insurance credit scoring many 
times before legislatures and administrative agencies including 
insurance departments and public utility commissions. He has 
provided expert testimony in litigation related to insurance 
credit scoring, and he has worked extensively in auto and 
homeowner's insurance availability in red-lining issues and is 
recognized as an expert in both economic and actuarial matters 
related to rates and risk classification. He received his 
training in economics from M.I.T., where he earned a master's 
degree in management and urban planning.
    Our fifth witness is Mr. Eric Rodriguez of the National 
Council of La Raza. Mr. Rodriguez is deputy vice president at 
the National Council of La Raza, the largest national Latino 
civil rights organization in the United States. He helps in 
that capacity to supervise and coordinate core operations of 
the Office of Research Advocacy and Legislation, and he's 
responsible for providing strategic guidance for public policy, 
legislative, and advocacy activities related to economic 
mobility and economic security policy issues. This work 
involves coverage of a wide range of issues including Federal 
budget tax, banking, homeownership, and social security. He 
holds a B.A. degree from Sienna College in New York and a 
master's degree in public administration from American 
University in Washington, D.C.
    And our final witness will be Mr. Nathaniel Shapo, who is a 
partner in the law firm of Katten, Muchin and Rosenman's 
litigation and dispute practice in Chicago, Illinois. He served 
for 4 years as director of the Illinois Department of Insurance 
where he consulted with Congress and Federal bank regulators on 
the Gramm-Leach-Bliley Financial Services Modernization Act, 
and helped draft the National Association of Insurance 
Commissioners' statement of intent for the future of insurance 
regulation. He has been named as a ``renaissance regulator'' by 
Best Review, was chosen for Crain's Chicago Business 40 Under 
40 list of newsmakers and groundbreakers, and he has been a 
lecturer in law and has served as a member of the visiting 
committee of the University of Chicago Law School. He earned 
his B.A. and J.D. degree with honors from the University of 
    We welcome each one of our witnesses. Without objection, 
each witness' written statement will, in its entirety, be made 
part of the record, and each witness will be recognized for a 
5-minute summary of their testimony.
    Let's start, if we may, with Commissioner J. Thomas Rosch. 
You are recognized for 5 minutes or thereabouts.

                    FEDERAL TRADE COMMISSION

    Mr. Rosch. Thank you very much, Chairman Watt, Ranking 
Member Miller, and distinguished members of the subcommittee.
    I very much appreciate this chance to speak about the 
Commission's report on the impact of credit-based insurance 
scores on consumers of car insurance. I'm afraid there's a 
danger here that the forest will get lost in the trees, the 
trees in this case being criticisms about the methodology used 
in compiling the Commission's report. Please don't 
misunderstand me. I have the greatest respect for those voicing 
the criticisms including those at the table, especially, 
however, for Commissioner Harbour, who's not only a colleague 
but a very close friend of mine. But I'm concerned lest the 
critiques obscure the report's two critical conclusions.
    The first conclusion is that credit-based scores do 
effectively predict risk under car insurance policies. That 
conclusion isn't affected by debates over whether the 
Commission should have gotten additional data bearing on that 
issue, whether it should have gotten that data from more 
insurance companies, or whether it should have used compulsory 
process to get the data that it got.
    There are two fundamental reasons why those debates don't 
impact that conclusion. First, the data that came from 
insurance companies came from companies representing more than 
25 percent of the market, and those companies submitted written 
assurances of the information's reliability, assurances which 
if false would support criminal prosecution.
    Second, the report's conclusion in this respect wasn't just 
based on data that came either directly or indirectly from 
those insurance companies. The reliability of the data from 
those sources was cross-checked by performing the same analyses 
based on claims data obtained from ChoicePoint's CLUE database, 
and I'm referring now to its comprehensive loss underwriting 
exchange database. And beyond that, the conclusion was 
supported by the Texas study, whose methodology critics say 
should have been used by the Commission.
    The second critical conclusion of the report is that 
credit-based scores are distributed differently among racial 
and ethnic groups, with African-Americans and Hispanics, on 
average, being more likely than others to have lower scores. 
Accordingly, insofar as credit-based scores are used, they're 
likely to result in higher car insurance premiums being charged 
to African Americans and to Hispanics than to others.
    Again, that conclusion isn't affected by the current 
debates over methodology. The data supporting that conclusion 
didn't come from the insurance policies at all because they 
don't track the race or ethnicity of their policyholders. It 
was instead based on inferences about the race and ethnicity of 
car owners drawn from data whose sources were the Social 
Security Administration, the Bureau of the Census, and 
information from an Hispanic surname matching firm. Again, the 
report's conclusion was consistent with the Texas study.
    Nothing in the report tries to blur that second conclusion. 
As my colleague Commissioner Leibowitz pointed out in his 
concurring decision when the report was issued, this conclusion 
serves as a reminder of the fact that some things, even today 
in our society, may adversely affect racial and ethnic 
minorities. And as Commissioner Harbour pointed out, it 
underscores the importance of educating minorities about the 
use of credit scores in pricing insurance and the importance of 
avoiding borrowing practices that can adversely affect their 
credit scores. We at the Commission have devoted substantial 
resources and will continue to do so.
    All that said, Mr. Chairman, the Commission has carefully 
considered the concerns about methodology that have been raised 
about our automobile insurance study. A majority of the 
Commission, four of us, continue to believe that the methods 
used were sound and that the findings made and conclusions 
reached were supported. But I speak for all five of us in 
emphasizing that we believe it's important for the public to 
have confidence in Commission reports. To that end, in our 
study of the impact of credit-based scores on consumers of 
homeowner's insurance, the Commission intends to use our 
authority under Section 6(b) of the FTC act to get policy 
information from insurance companies. A description of our plan 
for the homeowner's insurance study, including the use of 6(b) 
orders, is set forth in our recent letter from Chairman Majoras 
to Chairman Frank, to you, Chairman Watt, and to Chairman 
    Thank you for your time and interest today, and I look 
forward to answering any questions you might have.
    [The prepared statement of Commissioner Rosch can be found 
on page 109 of the appendix.]
    Chairman Watt. Thank you for your testimony.
    Commissioner Schmidt, you are recognized for 5 minutes or 

                   INSURANCE, STATE OF HAWAII

    Mr. Schmidt. Thank you, Chairman Watt, Ranking Member 
Miller, and committee members. Thank you for this opportunity 
to testify on credit-based insurance scoring, and to provide 
some background on why policymakers ban this practice in the 
50th State. In 1987, the Hawaii Legislature amended the Hawaii 
Revised Statues to prohibit discriminatory practices in the 
pricing of automobile insurance premiums. The law applies to 
rating plans, ratemaking standards and underwriting standards, 
and bars use of race, creed, ethnic extraction, age, sex, 
length of driving experience, credit bureau rating, marital 
status, or physical handicap in the direct or indirect pricing 
of Hawaii's automobile insurance premiums.
    Then as now arguments were made that credit scoring is an 
accurate predictor of the number of and total cost of claims. 
Arguments were also proffered both for and against the promise 
that credit scoring results in unfair and discriminatory 
pricing for low-income and minority groups.
    In its deliberations on this issue 20 years ago, the Hawaii 
Legislature determined that the use of credit bureau rating 
reports could result in discriminatory rating practices and 
acted to specifically include credit bureau rating in the list 
of prohibited criteria. Two decades later a report to Congress 
by the Federal Trade Commission reports that credit-based 
insurance scores are distributed differently among racial and 
ethnic groups, and that this difference may result in higher 
insurance premiums, on average, that these groups pay. While 
it's been actuarially demonstrated that there is a correlation 
between an individual's credit score and the propensity for 
that individual to be involved in future claim activity, that 
relationship only provides a portion of the information needed 
to develop and to regulate an insurance rate regulatory system.
    It's essential that policymakers have the flexibility to 
consider any corollary effects that may result from the 
criteria used in the insurance classification system. A good 
legal regulatory system balances the various and varied factors 
providing appropriate consumer protection with as little 
government intrusion as possible. The result should be a 
healthy, competitive market providing fair treatment and rates 
to consumers.
    It was determined by the Hawaii Legislature that any 
benefits accruable to some consumers by allowing credit bureau 
scoring as a rating factor in automobile insurance pricing were 
outweighed by the potential for harm to a greater number of the 
State's citizens and to its economic wellbeing. In this regard 
the legislature's policy decision accomplished a major goal of 
a risk classification system to produce rates that are not 
unfairly discriminatory. It is essential to recognize and 
acknowledge that credit scoring, if allowed and given 
jurisdiction, will per force result in all insurers giving 
consideration to use of credit-based insurance scores, 
regardless of whether they would have opted to use the criteria 
on their own in order to avoid adverse selection.
    Another important factor to consider is that credit scoring 
likely may present obstacles to employers, particularly small 
businesses, during less than favorable economic times, which 
would be counter to the economic goals of the State and Nation. 
Small business owners may have to borrow funds during economic 
downturns in order to keep the business going and to keep 
employees on the payroll. A rating system based upon credit 
scores may add additional surcharges and burdens when those 
burdens are most potentially harmful, adding to the economic 
problem due to intolerable marginal cost increases associated 
with the purchase of insurance.
    Why is this State like any other? The one thing we do hold 
in common with our 49 sister States is our firm belief in home 
rule. Legislative and regulatory processes must be tailored to 
best fulfill the needs of a particular region, taking into 
consideration its demographics, business climate, and social 
structure. As in other areas of law, one size does not fit all 
in establishing a legal structure for auto insurance. This 
concept is embodied in the guidelines of the Actuarial 
Standards Board of the American Academy of Actuaries, which 
avoid placing undue restraints on actuarial lawmakers by not 
requiring a specific system of specific rating criteria while 
allowing the balance of numerous pertinent factors under tested 
actuarial guidelines.
    In summary, 20 years of experience has provided no evidence 
that Hawaii statutory exclusion related to the use of credit 
bureau ratings in the pricing or underwriting of insurance has 
diminished the efficacy of the Hawaii insurance market. The 
current automobile insurance environment in Hawaii is 
competitive and healthy. And while the argument continues over 
whether credit scoring discriminates unfairly against low-
income and minority groups, I can assure you with 100 percent 
confidence that such discrimination does not exist today in the 
Aloha State.
    Thank you again for the opportunity to address this 
honorable body and to share with you Hawaii's approach and 
experience with this important insurance law policy.
    [The prepared statement of Mr. Schmidt can be found on page 
152 of the appendix.]
    Chairman Watt. Thank you, Commissioner, for your testimony. 
Commissioner Kreidler, you are recognized for approximately 5 


    Mr. Kreidler. Thank you, Chairman Watt, Ranking Member 
Miller, and distinguished members of the committee.
    I'm here to testify on ``Credit-based Insurance Scores: Are 
They Fair?'' My name is Mike Kreidler. I'm the elected 
insurance commissioner of the State of Washington, and I serve 
on a number of committees nationally with my fellow regulators 
that deal with this particular issue.
    When I was first elected as insurance commissioner in the 
year 2001, the issue was really starting to hit full steam from 
the standpoint of consumers. I literally received thousands of 
complaints from consumers. They didn't understand what their 
credit history had to do with how much they paid for personal 
lines of insurance, like automobile insurance and homeowner's 
insurance. The insurance companies were using credit 
information very differently from one company to another, and 
consumers quite frankly were disgusted that they were seeing 
rate increases based on factors that they didn't understand or 
could not be explained to them.
    In 2002, I proposed legislation to our State legislature. I 
would have proposed an outright ban, but I couldn't go that far 
successfully so I went as far as I could to put the strongest 
laws into effect. And when it passed it was the strongest law 
that had passed up to that point as a direct result of credit 
scoring. Today, something like 48 States have stepped in to 
vary degrees of trying to put limits into effect.
    What we wound up doing is that we wound up saying that you 
couldn't cancel or non-renew a policy based on credit 
information. We also said that you couldn't because of the 
absence of credit history, the number of credit inquiries, 
because of medical bills, because of the impact of the initial 
purchase of a vehicle or a house, or the type of card--credit, 
debit, or charge--that you might have, or the available line--
that couldn't be used to either deny you or to be used as part 
of the rating for your insurance.
    In addition to that, we wound up saying that if the insurer 
wound up using bad information, they retroactively had to 
adjust the premiums that you had been paying under the bad 
information. In addition to that, we required enhanced adverse 
action statements, in effect saying that consumers deserved the 
right to know why they didn't get the best rate.
    All of that helped, but in my mind it still doesn't go far 
enough and I'm still deeply concerned about the--that it 
thoroughly discriminates against protected classes and the 
economically disadvantaged.
    Insurance by its very nature discriminates. If you have a 
teenager on your policy, you quickly realize that this 
discrimination takes place. Our job is to make sure that credit 
scoring does not unfairly discriminate and harm protected 
classes of people.
    Unfortunately--in our State we attempted to do a study, but 
because of the demographics and small ethnic minority 
populations in our State, it was inconclusive. We relied on the 
FTC; we hoped that the FTC would provide answers to the 
questions about unfair discrimination. After 3 years, we got 
the report that confirmed my suspicion that, in fact, there is 
a disparate impact on protected classes.
    The study indicated that African Americans and Hispanics 
are strongly overrepresented in the lower step, lower scores, 
and underrepresented in the higher scores. To me that looks 
like it's a pretty straightforward case, yet the FTC report 
reached the conclusion that credit scoring is not a proxy for 
race. That seems somewhat counterintuitive to me.
    Now, what I saw--was most disappointed in, was that there 
appeared to be a real disconnect in being able to explain why 
there was this disproportionate representation in lower credit 
scores and yet it was not a proxy for race. I also saw that 
there was incomplete data for the purposes of the study, and 
only a few insurers did participate and did not identify the 
data so that it could be appropriately verified.
    Should we allow credit scoring even if it may have--be a 
valid indicator of risk, or does it have a disparate impact on 
protected classes and should be banned?
    Insurance commissioners dealt with this issue on race-based 
premiums in life insurance. When it was obvious that life 
insurance companies used different actuarial tables for African 
Americans, we went in, did a multi-state examination, reached 
settlements with life insurance companies, and they wound up 
paying back the premiums that they had been charging people 
over the years. It was recognized as public policy and equal 
protection as something that we needed to do.
    What we're looking at right now is that if we were to ban 
credit scoring, what would be the net effect? Well, it just 
simply will wind up redistributing how much we pay. It's 
certainly not going to have an overall positive effect for 
everybody or a negative impact. It just redistributes how much 
you pay.
    We heard that in the description from what the experience 
has been in Hawaii, but don't be confused here. We're also 
starting to see multiple other factors that are starting to 
creep in like education and occupation along with credit 
scoring. It makes me, quite frankly, very nervous.
    In closing, let me just say I realize that probably banning 
credit scoring is going to be a tough proposition but there are 
some things you can do. Let me recommend three of them:
    One of them would be to restore the adverse action notices 
to be consistent with legislative intent in the face of the 
recent U.S. Supreme Court case, Safeco v. Burr. The second is 
to use adverse action and statements to consumers that are 
meaningful, much like what Washington has done in explaining 
why they're not getting the best rates. And third, if insurers 
want to use these multiple factors, insurers should have to 
prove that their models are not unfairly discriminatory; make 
them prove it if they want to use it.
    Thank you, Mr. Chairman. It is my pleasure to be here 
    [The prepared statement of Mr. Kreidler can be found on 
page 79 of the appendix.]
    Chairman Watt. Thank you so much. Maybe I'll find a life 
after Congress one of these days, following in your footsteps.
    Mr. Birnbaum, you are recognized.

                        ECONOMIC JUSTICE

    Mr. Birnbaum. Thank you very much, Chairman Watt, Ranking 
Member Miller, and members of the committee. I really 
appreciate the opportunity to visit with you today.
    As you know, insurance scoring is basically the practice of 
insurance companies using consumers' credit histories to 
determine whether they're eligible for insurance, what types of 
coverage they're going to be offered, and what premiums they're 
going to pay. And basically the credit information has become 
one of the most important if not the most important factor that 
companies consider in determining what to charge you.
    For auto insurance, it has become more important than your 
driving record, in many cases. And the fact that the companies 
use more than one factor or they use factors in addition to 
credit doesn't diminish the importance of credit. Credit alone 
can make the difference of 100, 200, 300, or even 400 percent 
in a consumer's rate, so the fact that companies use multiple 
factors is really irrelevant. It's the impact of credit.
    Many organizations have called for a ban on credit scoring. 
They include the consumer and civil rights organizations that 
you mentioned earlier, but there are also agent organizations. 
The Allstate agents organization, State Farm agents, Farmers 
agents, they've all come out for a ban. The folks who would 
benefit from any tool that allows them to write more business 
are the ones who are coming out saying we want this practice 
banned because it's unfair.
    There are insurance companies who oppose it. In 
Massachusetts where they're talking about allowing credit 
scoring, there are insurance companies that want to prohibit 
it, including Arbella Insurance.
    The case for such a prohibition is actually quite strong. 
First of all, credit scoring undermines the core functions of 
insurance. It really provides disincentives for loss 
prevention. Instead of providing consumers with incentives to 
drive safely, spend $200 on a driver's safety course, it 
encourages people to spend $200 for a credit repair or credit 
checkup, things that have absolutely nothing to do with actual 
    It discriminates against low-income and minority consumers. 
This is pretty clear. This leads to higher rates for those 
consumers who are least able to afford the insurance in the 
first place, so it increases uninsured motorist rates, which is 
what the FTC study found, and of course it makes poor people 
into criminals because they can't comply with financial 
responsibility laws.
    It's arbitrary and unrelated to how well a consumer manages 
her finances. Your score can vary from good to bad depending on 
which bureau, which of the three credit bureaus provides the 
information, because the information is different.
    Your score can also vary from good to bad, depending on 
what time of the month it's taken. If it is at the end of the 
month, right before you pay your bill, you will have a high 
balance-to-limit. If it is taken a week later, you get a better 
score because your limits are now--your balance-to-limits is 
now lower.
    It is arbitrary because of the financial institutions that 
you use. If you live in a neighborhood where the financial 
institutions are payday loans, check-cashing operations, and 
rent-to-own, they don't report to credit bureaus, so you don't 
have information and you get charged higher rates even if you 
pay your utility bills and all your other bills on time.
    You can manipulate a credit score. There has been ample 
information about how you can go in and change a few things, 
and quickly manipulate your score. How can that be an objective 
measure when you can manipulate the score? It's not like your 
driving record; you can't manipulate whether or not you have 
had an accident.
    It's inherently unfair because it victimizes people who 
have experienced economic or medical catastrophes. Look at the 
people who were the victims of Hurricane Katrina--who but an 
insurance company actuary would say that it's fair to charge 
people who have been displaced from their homes higher auto and 
homeowner insurance rates because they're under financial 
stress? I don't know of anyone.
    Think about how this practice penalizes people for the 
business decisions of lenders. Let's put aside the fact that 
companies issue 6 billion credit card solicitations a year, 
throwing credit at people. Look at the abuses in the student 
credit card market, look at the abuses in the subprime market. 
Why should those consumers be penalized with higher auto and 
homeowner's insurance rates because of the faulty business 
decisions of lenders?
    The insurance industry offers a variety of claims about how 
credit scoring benefits consumers. These are all illusory. 
There is no substance to any of these claims. It all comes down 
to if we can predict risks better then we can do a better job.
    There is however strong evidence that credit scoring is in 
fact not correlated to risk, that it's a proxy for some other 
factor that's really at play. For example, over the last 10 
years we have seen an explosion in the number of bankruptcies, 
delinquencies and debt load. These are all things that are 
supposed to have great weight in a credit score and yet, while 
these things are going up, auto claim frequency is going down. 
So how can that be?
    If all of a sudden the number of young people in the 
population doubled, youthful drivers doubled, you can be sure 
there'd be an increase in claims. How is it that this increase 
in the number of bad credit risks doesn't yield an increase in 
    The FTC didn't even address stuff like that. So there's 
plenty of other evidence, but I'm going to just finish up 
quickly by saying the FTC study is really flawed. And not only 
that, it's unresponsive to what you asked for.
    The failure to obtain a comprehensive data set rendered the 
study really meaningless. There's no application data in it. 
It's only data on policies that were issued, which means that 
all of the people who were denied coverage because of credit, 
all the people who were priced out of the market because of 
credit dropped out. And we know that portion of the population 
is disproportionately poor and minority.
    So the impact that they did find, the impact on poor 
minority consumers, was dramatically understated from the 
reality of the marketplace. The study was flawed because it 
turned on a theory that more accurate pricing would result in 
more availability into a conclusion, despite the fact that 
their own findings disputed that.
    They found that the number of uninsured motorists 
increased. They found that the number of people denied coverage 
and ending up in the assigned risk market increased. How do you 
basically say that supports the conclusion that credit scoring 
promotes availability?
    The most disturbing part of it was the failure to address 
this ``blaming the victim'' mentality, that somehow people who 
have bad credit scores are really just--they just don't manage 
their credit well, and if they don't manage their credit, they 
can't manage their auto risk.
    The fact of the matter is, and Fair Isaac, the credit 
modeler has stated that 20 percent of the population is 
unscorable using traditional credit information. There's not 
enough information in the credit report.
    That 20 percent is disproportionately poor and minority. 
How can you say that those people whose information is 
insufficient in the files, how can you say that those people 
are at fault?
    Let me finish up by saying that there is really no need to 
further study this issue. There is ample information to justify 
a prohibition, but if you do want to study this, our view is 
that the FTC has really demonstrated that it is incapable of 
doing this without bias and if you want a study you should ask 
the GAO to do it and get the active participation of State 
insurance regulators who have the clear authority to demand and 
collect the information from insurance companies.
    We think that these are the folks who really are in the 
business of regulating credit scoring and they should be the 
ones who have a much more active role than they do.
    I'm happy to answer questions and thank you again for the 
opportunity to visit on this issue.
    [The prepared statement of Mr. Birnbaum can be found on 
page 47 of the appendix.]
    Chairman Watt. Thank you for your testimony.
    Mr. Rodriguez, you are recognized for your statement.

                       COUNCIL OF LaRAZA

    Mr. Rodriguez. Thank you, Chairman Watt, Ranking Member 
Miller, and distinguished members of the committee.
    For over a decade I have supported, led, and directed the 
National Council of LaRaza's legislative and advocacy 
activities on economic and financial security issues.
    In that time we have studied closely the staggering rates 
and ethnic wealth gap among American households and we have 
come to understand how policies and practices within financial 
markets perpetuate exploitation and unfairly distribute wealth 
opportunity among families. Disparity in overall wealth between 
Hispanic and non-Hispanic white households is greater than ten 
to one.
    More Latinos today own cars than own homes; about 80 
percent of Latino households report owning at least one car, 
but only half of Latino households own their own homes. Unfair 
practices in the auto industry stand to have a widespread 
impact on the Latino community.
    Research also shows that Latinos tend to pay more than 
necessary to finance their car. One study found that regardless 
of creditworthiness, Latino borrowers paid on average $266 more 
in finance costs per loan than non-Hispanic borrowers.
    In addition, there is a well-documented history of 
redlining and race-ethnic discrimination in the insurance 
industry. Altogether, whether negotiating the price of a car or 
arranging financing or securing insurance, Latinos are paying 
more than their white peers, and the experience of Latinos in 
the car market mirrors their experience in U.S. credit markets 
more broadly.
    In some cases uneven and unfair treatment is a reflection 
of outright discrimination, but in many cases it is the 
application of policies and practices in financial markets that 
produce unfair results.
    Approximately 35 million to 54 million Americans remain 
outside the credit system. In other research, about 18 million 
credit eligible Americans had credit files too thin to score 
and another 17 million had no files.
    The problem of thin and no-credit files is particularly 
acute among immigrants and youth. As a result, one study found 
that 22 percent of Hispanic borrowers had no credit score, 
compared to 4 percent of whites and 3 percent of African 
    Latinos have thin credit files for a number of important 
reasons. A substantial share are unbanked. More than a third of 
Hispanics lack a basic checking and savings account. Credit 
scoring models weigh heavily length of credit history. 
Meanwhile about 45 percent of Latino adults in the U.S. are 
foreign born. Also more than half of Hispanics, either native 
or foreign born, are under the age of 27.
    Latinos are also less likely than their peers to use credit 
cards. Only 56 percent of Latino households report having a 
credit card, compared to 80 percent of all households. Despite 
this, the FTC report on credit-based insurance scores reported 
a small share of the overall population with no credit scores.
    More incredibly, the FTC study found that it was more 
difficult to find credit reports for African Americans than 
Latinos. According to the study, credit reports could not be 
located for 9.2 percent of the Hispanic population compared to 
9.7 percent of African Americans and 7.8 percent of non-
Hispanic whites.
    These data are counterintuitive and should have given the 
FTC some pause. Instead, the report concluded that not having a 
credit score was unlikely to be an important source of 
difference in auto insurance premiums among race and ethnic 
groups. That said, the study did find that consumers for whom 
scores were not available appeared riskier when scores were 
used than when scores were not.
    In this case, no credit report automatically resulted in a 
high-risk designation within insurance scoring models. This 
finding, coupled with the results of the Federal Reserve study 
on credit scoring, documents the problem for Latinos.
    The Federal Reserve confirmed that foreign-born consumers 
consistently performed better than predicted by their credit 
scores. As the studies revealed, credit scoring adversely, 
unfairly, and disproportionately impacts those who are young 
and foreign born, a substantial share of the overall Latino 
    So what can we do about this? Hispanics have experienced a 
long history of exploitation and discrimination at the hands of 
insurance agents and companies. This is how insurance redlining 
emerged as the major civil rights issue.
    Insurance scoring does have the benefit of removing a 
measure of discretion that in the past resulted in outright 
discrimination against Latinos, however credit-based insurance 
scoring models undeniably result in Latinos and African 
Americans paying more for insurance than their white peers. 
That alone ought to raise caution flags for industry, 
regulators, and policymakers.
    The use of credit information in insurance scoring models 
is now ubiquitous. Many States have taken steps to address 
public concerns about this development, but State policy is 
inconsistent. Unquestionably there should be a prohibition 
against using credit information for those consumers who have 
no credit score or thin credit files.
    Other recommendations worth considering include the 
following: improve consumer information; improve transparency; 
improve oversight; and encourage voluntary improvements in 
credit scoring models. Of course, we have lots of ideas on how 
to do that well and we hope to share those with others moving 
    We thank you again and look forward to your questions.
    [The prepared statement of Mr. Rodriguez can be found on 
page 101 of the appendix.]
    Chairman Watt. Thank you so much for your testimony.
    Mr. Shapo, our final witness, is recognized for his 


    Mr. Shapo. Chairman Watt, Ranking Member Miller, and 
members of the subcommittee, it is good to see you again. Thank 
you for the opportunity to appear before you regarding the use 
of credit-based insurance scoring.
    The FTC study verifies that by using credit-based insurance 
scoring automobile insurers are more precisely evaluating and 
classifying risks. As a result, consumers are grouped and 
paying premiums according to their likelihood of incurring a 
claim against the common fund.
    The study also quells fears that credit-based insurance 
scoring is a proxy for racial or ethnic discrimination. The 
results of the FTC study thus demonstrate that credit-based 
insurance scoring achieves a basic norm of fairness found in 
the state of unfair discrimination laws. It is a wholly legal 
and appropriate method of risk classification.
    Before further discussing the study, it is worth discussing 
the prevailing legal and policy framework in the States 
pertaining to risk classification, in order to apply the 
standards and mandates under which automobile insurers have 
been instructed to go about their business by the insurance 
    As explained by Maryland's highest court, ``unfair 
discrimination, as the term is employed by the insurance code, 
means discrimination among insurers of the same class based 
upon something other than actuarial risk.'' Unfair 
discrimination as explained by a New York court recently ``is a 
word of art,'' used in the field of insurance, which in a broad 
sense means the offering for sale to customers in a given 
market segment identical or similar products that differ in 
probable cost.
    Insurance risk classification schemes by necessity group 
people by their shared characteristics, be it age, gender, 
driving record, scholastic achievement, or credit-based 
insurance scores. Some grouping methods have been found by 
insurers and regulators to serve as actuarially significant 
factors in predicting a person's risk of future loss.
    Thus, the unfair discrimination laws focus on whether a 
risk classification standard factor is actuarially sound. In 
addition to the basic unfair discrimination standard, the State 
insurance codes prohibit using a protected class such as race, 
national origin, or religion as a classification factor 
regardless of its actuarial use.
    The courts have explained very plainly that the law's focus 
on grouping consumers by actuarial risk establishes a basic 
norm of fairness. The Massachusetts Supreme Court crisply 
explained the consumer benefits, ``the intended result of the 
process is that persons of substantially the same risk will be 
grouped together, paying the same premium, and will not be 
subsidizing insurers who present a significantly greater 
actuarial hazard.''
    The Florida Appellate Court put it another way, approvingly 
citing an administrative law judge's holding that ``the most 
equitable classification factors are those that are the most 
actuarially sound.'' They did settle on a case supporting the 
use of the classification factors of gender, marital status, 
and scholastic achievement.
    In Louisiana Appellate Court, a decision supporting the use 
of age and gender boiled down the legal issues in a very 
practical way that is worth quoting at length: ``The evidence 
taken by the commissioner indicates that there exists a sound 
statistical basis for using classifications based on age and 
sex in fixing insurance rates. It further appears that any 
classification system which results in different classes paying 
different rates for the same protection is, to some extent, 
    ``If, for instance, age and sex are not used as factors in 
establishing classifications in automobile insurance rates, 
women and all those over 24 years of age, or about 70 percent 
of drivers, would pay a higher premium, all those under 25 
years of age, about one-forth of drivers, would pay 
substantially less than what they are now paying. The older and 
more experienced drivers would therefore be discriminated 
against by having to subsidize the higher risk class of younger 
    The court continued explaining that the unfair 
discrimination statute requires that the classifications used 
in establishing rates be reasonable and not unfairly 
discriminatory. We agree with the trial judge that 
classifications based on age and sex are not unreasonable. In 
other words, although there is discrimination against the good 
young driver it is not unfair or unreasonable.
    This well-reasoned opinion puts in very practical terms the 
reason that the law requires insurers to group consumers based 
on actuarial risk and why the law encourages insurers to seek 
out better predictors of risk of future loss. That's because it 
leads to a fair result.
    Consumers put into the common fund in the form of premiums, 
in an amount proportional to what they are expected to take out 
in the form of claims. As explained by the courts, any and all 
risk classification methods result in some members of an 
actuarially riskier class paying more than they really will be 
    For instance, there are many teenage drivers who are, in 
fact, very safe, but they and/or their parents must pay more 
than older drivers and more than would be called for if we 
could chiefly evaluate every person's individual driving 
    But insurers cannot perform a comprehensive and accurate 
individualized test of each driver without incurring 
prohibitive costs, so they classify risks according to groups 
so long as they are not protected classes such as race, 
national origin or religion.
    The social benefits of actuarially sound risk 
classification, as explained by the courts are, according to 
the FTC study, furthered by the use of credit-based insurance 
scoring. In fact, the conclusions of the study precisely 
tracked the explanations at the Louisiana court and others 
regarding the basic fairness of actuarially sound risk 
    The study states that credit-based insurance scores are 
effective predictors of risk under automobile policy, 
predictive of the number of claims consumers file and the total 
cost of those claims. The use of scores is therefore likely to 
make the price of insurance better match the risk of loss posed 
by the consumer.
    Applying the well-established law and prevailing public 
policy discussed above, the findings of the FTC study precisely 
established that the use of credit-based insurance scoring is a 
legal, appropriate, and fundamentally fair risk-classification 
method by automobile insurers.
    The study further found that credit-based insurance scoring 
has a benign affect on minorities when compared with other 
established risk-classification methods: ``Several other 
variables in the FTC database have a proportional proxy effect 
that is similar in magnitude to the small proxy effect 
associated with credit-based insurance scores.''
    This mirrors the result of the legislatively mandated study 
performed in Texas by former commissioner Jose Montemayor. 
Commissioner Montemayor told the commissioner and the 
legislature, ``Prior to the study, my initial suspicions were 
that while there may be a correlation to risk, credit scoring's 
value in pricing and underwriting risk was superficial, 
supported by the strength of other risk variables; the study 
however did not support those initial suspicions; credit 
scoring, if continued, is not unfairly discriminatory as 
defined in current law because credit scoring is not based on 
race, nor is it a precise indicator of one's race.''
    And the recent Federal Reserve study in a non-insurance 
context gives further comfort regarding concerns about credit 
scores and demographic effects.
    In summary, credit-based insurance scores are an excellent 
predictor of future risk, consistent with and indeed a 
manifestation of the legal and policy framework under which 
insurers function as a regulated entity, a fair, legal, and 
appropriate method risk classification and as a result 
beneficial to consumers.
    Mr. Chairman, I see that my time is up, and I would again 
like to extend my sincere thanks for the opportunity and 
privilege to appear before you.
    [The prepared statement of Mr. Shapo can be found on page 
155 of the appendix.]
    Chairman Watt. Thank you so much. Let me just thank all of 
the witnesses for laying out this issue and kind of setting the 
    Regardless of how you approach it, we need to have this 
discussion, and it is an extremely important discussion, and I 
don't think we could have had a better panel of witnesses to 
kind of put out the issues and start our evaluation and 
    I'm going to recognize each of the members of the 
subcommittee for questions in 5-minute blocks, and I will 
recognize myself for 5 minutes initially.
    And I want to get right to the bottom of this. I was struck 
by Commissioner Rosch's testimony that we need to educate 
minorities more about how to have better credit or how to get 
their credit scores up. And I guess my question is, if I got my 
credit score up, would that make me a better driver?
    Mr. Rosch. I think the answer to that is that the 
Commission's report takes absolutely no position whatever with 
respect to that, Mr. Chairman.
    Mr. Watt. So if there's not a correlation between my 
driving, which is what automobile insurance is about, I guess, 
isn't it? Is that what automobile insurance is about?
    Mr. Rosch. Well, it's about that, but it's also about 
things such as the frequency of claims. I mean I guess it can 
be said that there's certainly a logic--
    Mr. Watt. But is the frequency of claims related to driving 
    Mr. Rosch. Very definitely it's related to it, but there's 
not, as we would put it, a proxy effect involved there.
    Let me make it clear that what we're talking about here in 
our report are averages. We're not talking about your 
particular rates. We're not talking about mine.
    Mr. Watt. I understand that, but it strikes me as being--I 
mean I don't think you'll find a stronger supporter of the need 
for credit education and improving credit histories and credit 
scores. I think the problem I'm having is what in the world 
does that have to do with the insurance rates that I pay?
    And maybe I ought to ask the question this way. Is there 
some statistical--has there been a determination that African 
American drivers are worse drivers than white drivers?
    Mr. Rosch. No, there has not. There has not, Mr. Chairman.
    Mr. Watt. All right. I'm just trying to get this on the 
record so that we make sure that is the base that I'm operating 
from. And if that is not the case, I don't know how--what the 
justification is for basing--if you know that 
disproportionately African-Americans and Hispanics have lower 
credit scores, and you know that there's no correlation between 
race and safe driving, is there something else I need to know?
    Mr. Rosch. Well, let me make it clear what the Commission's 
report said and what it did not say, if I may, Mr. Chairman, 
because this really cuts right to the heart of your question.
    Chairman Watt. I'm trying to get to the heart of it.
    Mr. Rosch. The Commission's report took definitive 
positions only with respect to those matters which we felt were 
completely established beyond peradventure by the statistical 
analyses that were done. We interpreted your mandate that way, 
and those statistical analyses show that there was 
unquestionably a relationship, a correlation between credit 
scores on the one hand and the frequency of claims on the other 
    Chairman Watt. Okay.
    Mr. Rosch. No, just to finish up on this if I may, Mr. 
Chairman, we took no position on why that existed because we 
did not have a statistical basis for taking a position.
    Chairman Watt. Okay. That's fair. Let me ask two other 
questions quickly because my red light is going to come on, and 
I try to apply the same rules to myself even more vigorously 
than I apply them to the other members.
    I take it, Commissioner, that what you are saying is even 
if you take 2 more years or 3 more years to study this issue, 
the public may deem what you say as more--as having gone 
through a more methodical process. I guess the question I'm 
asking is would the end justify the means? Would we have 
anything better at the end of that 2 or 3 years than we have 
now based on the way you did this study?
    Mr. Rosch. The answer, I think, in all fairness, Mr. 
Chairman, is I don't know. We set forth in our letter to you 
and to Chairman Gutierrez and to Chairman Frank what we 
intended to do in terms of compulsory process the next time 
around. We also intend to get from consumer groups like that 
represented by Mr. Birnbaum, from LaRaza, from the insurance 
commissioners, their input--
    Chairman Watt. I understand all that, but I guess one of 
the concerns I have is that we may be pressing you into a 
process that you don't think is going to yield a better result, 
and it might look better to the public that you went through 
that process, but if the result is no better and no more 
reliable in your estimation, I guess I'm beginning to have 
second thoughts about whether we ought to be pushing you to do 
a study using a process that you can't verify to me is going to 
have a better--more reliable, not better, because we're just 
trying to get to the bottom of this; a more reliable conclusion 
to it.
    Mr. Rosch. Well, I think that's a perfectly legitimate 
question, Mr. Chairman. That is a decision for this committee 
and this Congress to make. I cannot sit here and tell you right 
now that the conclusions, the basic conclusion particularly 
that I described in my opening statement, with respect to 
homeowner's insurance, is going to be one bit different as a 
result of the use of compulsory process or the input that we 
receive in the future from these groups.
    Chairman Watt. I'm not worried about whether it's different 
or not. I'm worried about whether it would be more reliable. 
We're not looking to program the result, but we ought to be 
able to say at the end of the day that the study is reliable. 
And the question I asked you didn't have to do with whether you 
were going to change the result or not. The result might be 
exactly the same, but I don't want to do 2 or 3 years waiting 
for a study that's not going to be perceived as being any more 
reliable than the study you've already done in a much, much, 
much shorter and less extensive period of time.
    Mr. Rosch. I think that's a perfectly legitimate issue. All 
I'm trying to say, Mr. Chairman, is that as matters now stand a 
majority of our Commission feels that the data that we got, the 
data that we used for the current study was reliable. However, 
we are going to use compulsory process this next time to get 
the same kinds of data. The problem is that I can't sit here 
and tell you right now that the quality of that data is going 
to be any more reliable than that which we got the last time.
    I'm sorry. I misunderstood your prior question.
    Chairman Watt. All right. Let me ask, just because we are 
in this line of questioning and I want to be clear, would you, 
in the absence of the letter that Chairman Frank, 
Representative Gutierrez and I wrote to you, would you have 
used 6(b) process or would you have used the same process?
    Mr. Rosch. Frankly, I think that I would have voted to use 
6(b) process, and I can tell you why I would have voted to use 
6(b) process is that even apart from this committee's letter to 
the chairman questions have been raised about our lack of 
compulsory process this time around.
    As I said in my opening statement, we at the Commission 
feel that having the public have confidence in the way that we 
prepare our report is exceedingly important to us. Whether or 
not that's worth the time, the extra time it will take, is a 
matter for your--
    Chairman Watt. My time has expired. I'll come back to this 
on the second round. The ranking member is recognized, and I'll 
be as generous with his time as I was--
    Mr. Miller of California. Thank you. Years ago my attorney 
advised me not to ask a question that I wasn't sure I was going 
to get the right answer for because you might not hear what you 
expected to hear, and I think that kind of happened here with 
the FTC study. I mean when I read in the study, the data shows 
that drivers--I wasn't referring to you, I was referring to 
years ago.
    Chairman Watt. I did want to clarify that the two people 
who orchestrated this aren't even here today. You and I are 
just kind of innocent bystanders.
    Mr. Miller of California. But a question was asked and you 
based your answer on all of the available data that existed. 
Instead of what you believed, or what you heard, or what you 
suspected, you went to the insurance industry and then you 
verified that the information you got was genuine and real.
    And when the data comes back and says drivers with bad 
credit histories are more likely to have repeated accidents 
than those with good credit history, I don't know why gravity 
is there either, but it is. And the data that's in the 
marketplace today shows this to be accurate. I don't know why 
it's accurate, but it's accurate.
    And they went on to say that credit scores are the most 
objective method of determining insurance premiums and may help 
diminish the possibility that credit decisions will be 
influenced by personal characteristics or other factors 
prohibited by law such as race and ethnicity, which--I agree, 
you should not look at the individual, how they appear to you, 
and charge the rates based on that, nor the color of their skin 
or because I'm from Arkansas. I mean I shouldn't be 
discriminated against because I'm from Arkansas.
    So those are given. But the conclusion came back very 
consistent in all the reports, Texas, the Fed, and the FTC. And 
Mr. Shapo, I guess I'd like to ask you this question because 
you didn't prepare the reports, but when you look at the FTC 
release on their position that came forward in July and you 
look at what the Fed's recent studies said and you combine that 
with one that wasn't taken into consideration in the Texas 
study, what does the fact that these entirely different studies 
reached very similar conclusions tell you about the criticism 
level against the studies?
    Mr. Shapo. I think the studies are consistent, two of them 
specific to insurance and one of them, the Fed study, with 
respect to credit and its potential proxy effects. I think they 
clearly demonstrate that the use of credit-based insurance 
scoring correlates precisely with prevailing notions under both 
the law and public policy of what insurers are supposed to be 
    They're supposed to be using risk classification methods 
and they're mandated to use risk classification methods that 
correlate the amount of money, that correlate premiums, the 
amount of money put into the common fund, with claims, the 
amount of money taken out of the common fund. And this is a 
manifestation of the instructions insurers have been given 
under the insurance code for years.
    Mr. Miller of California. Mr. Rosch, you--preparing your 
conclusion in the study, you took this data and you verified 
that it was correct as you objectively could, is that not 
    Mr. Rosch. Well, what we did do is that we tried to 
determine, first of all, whether there was a correlation 
between credit scoring on the one hand and the frequency of 
claims on the other hand. And we did find that relationship. 
There was no question about that.
    However, the whys of that--
    Mr. Miller of California. That's my problem because I don't 
know why either.
    Mr. Rosch. I don't know why, and we took no position on 
that, Congressman, because we couldn't. We gave you the 
explanations that have been proffered by various people.
    Mr. Miller of California. And I appreciate that. I 
understand the difficulty you have. When--I've read your 
information in the reports. I don't know why either. But if 
something does what it does, it does it. And they're using a 
method to determine that would be most fair.
    I guess the problem that I had on Mr. Kreidler--not the 
problem but the one point that I picked up on that I thought 
was important, you said that banning the use of this would 
redistribute how we pay insurance premiums, and that's scary to 
me, because if credit scores have proven to be accurate--we 
don't know why; if you have bad credit or good credit, your 
driving record is based on that, accordingly if you have bad, 
you have a bad record, if you have a good score you tend to 
have a good record, I would hate to have that banned and 
everybody to start subsidizing people who have bad driving 
records because we don't want to accept it.
    But I guess the one question I had for Mr. Kreidler, and 
this is probably a stupid question, but do you think credit 
scores discriminate?
    Mr. Kreidler. I think insurance credit scores--
    Mr. Miller of California. No, I'm saying credit scores 
because all the insurance companies are doing is using a credit 
score. You either pay your bills or you don't pay your bills. 
If there is some flaw in the credit score, you can have that 
    I mean if somebody--I had a situation where somebody with 
my name in a different city didn't pay his bills. He happened 
to be a contractor 2 years ago, and I got my credit score back 
and I had this off rating, and I started looking at all the 
payments that were not made were not paid by this other jerk 
named Gary Miller.
    Mr. Kreidler. I think it's an underwriting tool. I think 
that credit scoring, credit scores are obviously going to 
discriminate. I think the real question, though, is does it do 
it fairly.
    Mr. Miller of California. But the question is do credit 
scores discriminate in and of themselves.
    Mr. Kreidler. In and of themselves? No, I think they're--
    Mr. Miller of California. Okay. Now back to Mr. Shapo.
    Could you explain how the insurance industry cooperated 
with the FTC in order to ensure that the data submitted for the 
study was accurate and reliable?
    Mr. Shapo. As Commissioner Rosch said, several carriers 
representing at least a quarter of the market provided data and 
submitted it with affirmations that would have subjected them 
to criminal penalties if the data was false or misleading.
    Mr. Miller of California. Mr. Rosch, you also said in your 
comments that the credit-based insurance scores are useful for 
predicting which individuals are more likely to file an 
automotive insurance claim versus those who don't. But does the 
inconclusive result indicate that the study is flawed in any 
    Mr. Rosch. I don't believe that's the case.
    Mr. Miller of California. So you think even though you 
don't know why it occurs, it occurs?
    Mr. Rosch. Correct.
    Mr. Miller of California. And, former Congressman, I can 
tell why you decided to go to work in Washington State. I was 
in the San Juans Islands about a month ago; I'd go there too. 
So you made a good choice.
    Mr. Schmidt, from the State of Hawaii, I don't understand 
why you're here at all. I'd rather hang in Hawaii any day than 
    But you note that a one-size-fits-all structure for setting 
automobile premiums likely wouldn't work, and that Hawaii is an 
especially unique State. Wouldn't the Federal banning be highly 
restrictive on credit scores and wouldn't that override the 
home rule concept you believe in?
    Mr. Schmidt. Yes, and I think it should be left up to the 
individual States to deal with that particular issue.
    Mr. Miller of California. Well, I'm going to yield back. I 
know you'd be kind, but I have two more gentlemen to ask 
questions, so I want to yield back.
    Chairman Watt. I appreciate it. We'll do a second round, 
but it is fair to them, to the other members, to allow them to 
go ahead in case they have other commitments.
    Mr. Roskam is now recognized for his questioning.
    Mr. Roskam. Thank you, Mr. Chairman. First of all, to all 
six of you witnesses, I appreciate your taking the time to give 
us the benefit of your wisdom today, and I found it to be 
helpful and instructive.
    I guess, Commissioner, you're here in a sense because I 
think you're experiencing the same experience I had as a 
schoolboy, not to compare your work with my essays as a kid, 
but what I would do occasionally, and I would sense that others 
in this room have done the same thing, is you write an essay, 
and it's before that it's actually time to submit the essay and 
you go to the teacher and you say, hey, could you look at this? 
And the teacher will come back and say, hmm. Well, I think you 
need another paragraph here, and your conclusion isn't very 
good, and, you know, your margins aren't very well, and then 
you go back to your desk and you rewrite the essay and you 
submit it again and you get an A, lo and behold, because you're 
giving the right answers.
    And my sense is that there's a little bit of a subtext of 
the answers that you came up with on the first draft aren't 
necessarily the answers that everybody was looking for. So, 
hang in there with whatever version or incarnation of a study 
you come up with in the future. But I appreciate your 
evaluating the data, you know, under the mandate that you had, 
and you're calling balls and strikes the way you see them, and 
I know it tends to be sort of charged up area. But I appreciate 
your integrity in looking at those things.
    Commissioner Schmidt, when I was listening to your 
testimony it seems like your experience is actually very 
limited in that Hawaii--unless you have other professional 
experience that I'm not aware of--but since Hawaii banned 
credit scoring in the late 1980's, you don't have the same 
level of experience as a regulator that other States do that 
have dealt with it. So your testimony was conclusionary, but it 
was anecdotal based on your observations and not on your actual 
    Former Member Kreidler, my pen came out at the same moment 
that Mr. Miller's pen came out with your observation that to 
ban credit scoring will redistribute what you pay. And that 
is--that's part of really what's driving this coverage, isn't 
it? It is who pays what and how do we move forward? You know, 
you shared with us your experience in Washington, and your 
particular vantage point as an elected commissioner, which has 
different types of pressures than Mr. Shapo experienced in 
Illinois as an appointed commissioner. But I think that there's 
going to be sort of more said, and you'll find yourself quoted 
in absentia from time to time based on that observation. And I 
appreciate that, because it was--I think it was a forthright 
thing to say that once you change these models, once you take 
tools away and put different things in, people are going to pay 
differently, and I think that is something that this committee 
needs to be aware of.
    Mr. Birnbaum, when you said that credit scoring is a proxy, 
it sounded a little conspiratorial for me, and I'd love to have 
a conversation with you, maybe offline, to learn more about 
where you think the helicopters are coming over the hilltop. 
But I do seriously want to learn what you think the proxy 
battle is actually all about.
    But what I heard you and Mr. Rodriguez saying, and I think 
that this is maybe an area to work on, is this notion of people 
having thin files--I think that was the term of art that you 
used--but not enough information from a credit point of view, 
and those people would be left behind. And that's an area, I 
think a common ground, that if there is going to be credit 
scoring, there has to be an ability to, you know, include those 
things that some groups are using, phone bills, utility bills, 
and those types of things. And I think that's an area that we 
may all be able to come together in and focus in on.
    Mr. Shapo is the former director, clear thinking, good 
clear thinking from the land of Lincoln, and it was good to see 
you. Thank you.
    And with that, I yield back the balance of my time.
    Chairman Watt. I thank the gentleman. Mr. Price.
    Mr. Price. Thank you, Mr. Chairman. And I want to thank you 
and the ranking member for holding this hearing and I thank all 
the witnesses for their testimony. I am curious about the 
comments being made that we find a report, but we want a better 
    My statistics professor in college would chuckle at the 
thought that you could look at numbers and statistics and come 
up with a conclusion that was based upon those numbers and 
those statistics and then want a better result. It's a little 
perplexing to me. I think one can indeed ask for a more 
reliable result. But what I heard, Commissioner, you say, is 
that you felt that given the parameters of the charge put to 
you, that you feel that the conclusions that the Commission 
drew are in fact reliable and that there was a majority of the 
Commissioners who felt that. Isn't that correct?
    Mr. Rosch. That's correct.
    Mr. Price. And I think it's also important for us to 
appreciate that there may be no correlation whatsoever between 
credit scores and driving acumen, but I understand you to say 
and I understand your conclusion to be that there is a 
correlation between credit score and making a claim. That's a 
distinction that you draw. Is that accurate?
    Mr. Rosch. That's correct. Actually, the frequency of 
claims, Congressman.
    Mr. Price. So--I'm reminded of my father, who loathes 
insurance, but when he took it out, vowed never to file a claim 
because he didn't want his insurance to go up. So his insurance 
never went up and he probably paid more out of pocket than he 
would have otherwise, but be that as it may.
    Commissioner, I also was interested in your comment that 
you, at that point when you recognized or when you'd reached 
the conclusion, given the charge that was given to you, that 
you said, ``We didn't go any further because we didn't have a 
statistical basis to do so.'' Would you elaborate on that and 
why some may be troubled that the answer to their desired 
question wasn't given?
    Mr. Rosch. Yes. What we tried to do, and this is based on 
our understanding of our mandate, was that we gave you firm 
conclusions where we thought we could do so based upon the data 
that we had and the statistical analyses that we had. 
Otherwise, all we did was to report to you what others had said 
about the various matters that are covered in the report.
    For example, whether or not there are benefits to society 
as a whole in having this relationship between credit scoring, 
on the one hand, and claims frequency on the other. We took no 
position on that because we had no hard data to support any 
position on that.
    Secondly, we took no position on whether or not there was a 
relationship between credit scores on the one hand and whether 
or not African Americans or Hispanics were poor drivers on the 
other hand. We reported to you the various speculations with 
respect to why this correlation existed so that you could make 
up your own minds based upon that data. But we had no--and the 
report is quite specific about this--we had no hard data to 
support a conclusion on that. And consequently, we did not take 
a position with respect to it.
    So there are very definite limitations on our report to 
you, but that's as a result of how we understood our mandate.
    Mr. Price. I appreciate that, and I found the report to be 
factual and objective in the findings. And so I appreciate 
that. I want to, in the brief time I have left, address the 
issue of the dissent in the Commission's report. The dissenting 
opinion was that there was never provided in the Commission 
with written verification of the accuracy, authenticity, or 
representativeness of the data that was furnished. You alluded 
to this in that you said you would--you I think preferred to 
use 6(b) data if you were given the opportunity, or if you had 
that to do over again. Do you believe this comment, though, in 
the dissenting opinion to be a valid criticism?
    Mr. Rosch. I would always prefer--I will tell you as a 
Commissioner, I always prefer--maybe this is my training as a 
lawyer, but I would always prefer compulsory process to any 
kind of voluntary production. In this particular case, however, 
we, number one, we did receive written assurances from the 
insurance companies from whom the data came that the--as to how 
the data was gathered, and that it was accurate. And that is 
subject to criminal penalties.
    Number two, the data that we received was actual policy 
data. It would be hard to fiddle with that data if one were an 
insurance company or one were trying to interpret it.
    Number three, the most critical elements of this study were 
not based exclusively on the data that we got from the 
insurance companies. The data that we got with respect to the 
frequency of claims came instead mainly from Choicepoint's 
comprehensive loss underwriting database, which is an 
independent credit-scoring agency. It is not an insurance 
company. And number two, the data that we got with respect to 
ethnicity and race came not from the insurance companies, 
because they don't have that data, but rather from the Social 
Security Administration and the Census Bureau, as well as from 
the Hispanic surname matching service that I alluded to. So 
there were cross-checks.
    Mr. Price. Thank you. I appreciate it. I think that 
demonstrates the authenticity and the accuracy of the 
information. I want to thank the chairman again. I'm going to 
have to run, but I appreciate that. I am heartened by your 
comments that you continue to believe that insurance regulation 
ought to be left at the State level, and I'm pleased to hear 
    Chairman Watt. I don't think you've ever heard me express a 
different opinion, Mr. Price. Much to the dismay of all of the 
folks who are looking for an optional Federal charter.
    Mr. Miller of California. Except me. I think the optional 
Federal charter is a good option.
    Chairman Watt. See. This is not States' rights. This is a 
States' rights Democrat versus a raving liberal over here who 
wants to federalize everything.
    Chairman Watt. Let me--I appreciate you coming, and you're 
welcome to stay. We're going to go another round, just because 
I have some more questions. And probably even at the end of 
that round, I won't have exhausted all my questions.
    One of the great things I've found about being a Member of 
Congress that I didn't find about the practice of law was that 
when I was practicing law, I'd never ask a question I didn't 
know the answer to already, because you had to live with the 
consequences. I'm not interested in programming the outcome of 
the responses that I get, so this is just about making public 
policy now and getting honest assessments.
    I noticed, Mr. Rosch, that you've been very careful to talk 
about the frequency of claims. And maybe that's a term of art 
that translates into some other things. I'm interested in 
knowing whether the frequency of claims has a correlation 
between dollar amounts, payment of claims, the amounts paid. Is 
that all included in frequency of claims, or is it just the--
what is included in frequency of claims?
    Mr. Rosch. Frequency of claims does translate into higher 
premium--I'm sorry--total claims paid out.
    Chairman Watt. Okay. So it is inclusive of more than just 
the rate at which claims are filed?
    Mr. Rosch. That's correct. But I wanted--
    Chairman Watt. That's fine. That's not a trick question.
    Mr. Rosch. No, no. I understand.
    Chairman Watt. I am just trying to understand. You said 
that your analysis was limited to policy data. What do you say 
in response to Mr. Birnbaum's concern that one of the 
shortcomings of the analysis was that it didn't deal with 
denials, which probably, possibly would be disproportionately 
even greater racially disparate?
    Mr. Rosch. That I think is speculation at this point, Mr. 
Chairman. Let me make--
    Chairman Watt. But does--maybe I asked the question the 
wrong way. Does the data you used have the denials in it?
    Mr. Rosch. It does not have application data. And let me 
tell you why, if I may.
    Chairman Watt. Well, I--
    Mr. Rosch. Let me tell you why.
    Chairman Watt. Okay.
    Mr. Rosch. Because it really bears directly on whether or 
not the whole study was reliable. The first reason why is 
because insurance companies by and large do not keep 
application data. And what that meant back in 2001--
    Chairman Watt. I actually would be more interested in 
finding out whether you think that would be a relevant--I'm 
satisfied that your information doesn't include denials. And 
I'm satisfied that there are probably reasons why that is the 
case, very good reasons. Would denial information be an 
important factor to take into account?
    Mr. Rosch. If we could get it, Mr. Chairman.
    Chairman Watt. Yes. Okay. That's--
    Mr. Rosch. But the McCarran-Ferguson Act is--currently is 
as much a constraint on the Commission as it is on the 
    Chairman Watt. Okay. I understand, Mr. Rosch. I'm not being 
hard on the FTC.
    Mr. Rosch. No, I understand.
    Chairman Watt. These questions are not aimed at 
discrediting what the FTC has done. I'm just trying to get the 
bottom of this really. I don't understand how you can take 
something that appears to me to be unrelated. It's just common 
sense to me.
    And even if there were a correlation, I'm not sure I would 
be convinced that it would be appropriate to use something that 
correlated with race that had a disproportionate racial 
content. We outlawed it in the life insurance context. There's 
certainly a whole wealth of information, body of information 
that black people live shorter lives than white people, and we 
said, you just can't--I mean, you can't do that in setting 
insurance rates, because you have to do it on a gross basis. 
So, even if there is a correlation, I'm not sure I'd buy the 
notion that we ought be doing this.
    Mr. Rosch. Please, please don't take this report as 
    Chairman Watt. Okay.
    Mr. Rosch. --that we disagree with that one iota.
    Chairman Watt. All right. And I've heard you say that over 
and over again. I guess I have that bias coming in whether your 
study is reliable or not, and at some level I guess that's why 
I'm questioning whether we even need another study because it 
seems to me that if there is a proxy effect, even though 
statistically what you say is there's a reliable predictor of 
risk, I'm not sure if it's a fair predictor of how insurance 
rates ought to be set, I guess is the concern I have.
    What do you have to say about that, Mr. Kreidler? You all 
obviously decided regardless of what the circumstances were, 
that this didn't--well, let me ask a different question. What 
are the insurance companies in Hawaii and Washington State 
using if they are not using credit-based scoring?
    Mr. Kreidler. Mr. Chairman--
    Chairman Watt. And what impact does that have on your rate 
setting, which might be a better way to get to the bottom of 
    Mr. Kreidler. Well, as you pointed out, you know, Hawaii 
wound up with effectively banning it for auto whereas we're in 
a position that we've limited what you can use. The net effect 
is, is that I think we've done a better job of limiting the 
adverse impacts of credit scoring. Nobody has said it's not a 
predictor. What we're saying is, is it fair?
    I mean, I think your example of life insurance, we dealt 
with it, but there's also the issue related to lenders and 
redlining. Nobody said that if you redlined out the inner city 
that somehow that you weren't making loans probably more 
prudently. The question was, was it a surrogate for race? And I 
think that's the question right here. Is the use of credit 
scoring a surrogate for race? And if it is, then it should be 
banned. And we've answered it for life insurance. We've 
answered it for redlining on lending.
    I think the FTC came back and showed that, yes, there is a 
disparate impact, and you know, there's some real limitations 
on the study that they did. Not their fault, but because of the 
data. And I look at it and I say, you know, if this question is 
as clear as it appears right now, you should take the same 
approach relative to what you did for life insurance and what 
you did for redlining on lending.
    Chairman Watt. Commissioner Schmidt, what are you all using 
other than credit-based scoring in Hawaii?
    Mr. Schmidt. Yes. We're using driving history and the 
accident experience that individuals have. As I noted in my 
testimony, we not only ban credit bureau rating, but a variety 
of other factors which have an actuarial basis that show that 
there are difference in premiums that could be had based on 
gender, based on length of driving experience, age and other 
    But we do focus on what the actual driving experience and 
claims history was. During the course of this ban, 
Representative Roskam was right that we don't have necessarily 
the experience of having no credit reports being used and then 
having credit reports being used to compare it.
    But in my testimony, we have banned it for a number of 
years, and during that course of those years, we have had a bad 
and difficult auto insurance market based on some of the other 
laws that we had enacted where we had few companies writing, 
where we had high premiums. And then we made some reforms that 
enabled us to drop the premiums from third-highest in the 
Nation to 21st, one of the biggest drops of any State. And we 
have a very healthy auto insurance market now with lower 
premiums. And through both, we had the ban on credit scoring.
    So there still are valid criteria for evaluating the 
insurance rates that companies can use.
    Chairman Watt. My time has long since expired, and I 
recognize Mr. Miller.
    Mr. Miller of California. I was enjoying the red light. 
That's okay. To my knowledge, I don't think there's a State or 
an insurance company that doesn't use driving history. I mean, 
if--I don't want anybody to listen to this hearing today and 
assume that some insurance companies or some States are just 
using credit-based insurance scores. And I don't think anything 
in Mr. Rosch's report states that. I mean, they use multiple--
it could be 20 or 30 different things they take into--as a 
factor when they're determining somebody's fee they're going to 
    But it seems like all the reliable sources that have done 
the data research have come up with the conclusion for some 
reason, credit-based insurance scores are very predictable as 
it applies to loss. And I think that's all Mr. Rosch's report 
says, is that based on the information, if you have a bad 
credit score, you have a tendency to have many more claims than 
somebody who has a high credit score, has fewer claims or a 
better record.
    But, Mr. Shapo, can you describe how residual market rates 
have declined since credit-based insurance scores started to be 
used as an underwriting tool? And can you explain why this is 
the case?
    Mr. Shapo. The residual markets serve people who cannot 
obtain insurance through primary carriers, and they have been 
healthy and have gotten healthier since--in recent years. It 
seems to be a reasonable inference that, you know, that the use 
of credit scoring has not harmed people in that market sector.
    Mr. Miller of California. So rates have dropped by using 
    Mr. Shapo. It seems to be a reasonable inference.
    Mr. Miller of California. And the FTC said that credit-
based insurance scoring may reduce costs of granting and 
pricing insurance, and those costs generally are passed on 
through a competitive market to the person you're insuring. Is 
that a reasonable statement?
    Mr. Shapo. Yes. I think that was a clear--the way I read 
this study, that was a clear conclusion of the study, that it 
correlates risk to premium rates. It makes the amount people 
pay a more accurate representation of what they're expected to 
take out from the insurance company through the submission of 
claims. And on the whole, this--the report concluded that that 
will lead to both more accurate and better rates for a majority 
of drivers.
    Mr. Miller of California. Some States have taken the 
extreme and severely restricted the use of credit scores in the 
processing of insurance claims, writing insurance policies. So 
what effect does this regulation have on the availability and 
the affordability of insurance, in your opinion?
    Mr. Shapo. It's my general presumption that any 
restrictions that prevent a more precise allocation of premiums 
with respect to--in their correlation with risk, will 
ultimately not help and likely harm the availability and 
affordability of insurance in a State, because that, under, you 
know, fairly basic economic theory, will, you know, will 
impinge the working of a free market and harm the pairing of 
supply and demand.
    Mr. Miller of California. Back to you, Mr. Rosch. I'm not 
going to get to you, Mr. Schmidt, because you are crazy to be 
here. You should be in Hawaii. I'm telling you, anybody who 
would come to Washington rather than Hawaii--I mean that in a 
good way, my friend. I'd rather be right now on vacation.
    Mr. Rosch--
    Mr. Rosch. I'm from California.
    Mr. Miller of California. Yes. I move we adjourn and 
reconvene this in Honolulu or something. Is that feasible? Mr. 
    Mr. Schmidt. That's a good idea.
    Mr. Miller of California. I knew you'd like that. The 
report states that the theory that credit scores are solely a 
proxy for race or ethnicity cannot be upheld because credit 
scores are predictive within racial and ethnic groups as well 
as within general population. Can you elaborate on that?
    Mr. Rosch. Actually, Congressman, the report says that it 
is not solely a proxy. It does not rule out a proxy effect by 
any matter of means. It says that because it is predictive 
within each of those racial groups, it cannot be considered 
solely a proxy, and I think that is simply a matter of logic.
    However, we didn't stop there. There was a second test that 
was done, first of all to determine the extent to which there 
were increases in the risk for each of these groups, and it 
turned out that for African Americans, the average predicted 
risk went up by 10 percent, and for Hispanics by 4.2 percent. 
And then we tried to figure out how much of that 10 percent and 
how much of that 4.2 percent was attributable to--could be said 
to be attributable to race and thus be said to be a proxy 
effect. And we found that in the case of African Americans, it 
was about 1 percent of that 10 percent. And in the case of 
Hispanics, it was about .7 of that 4.2 percent.
    So I think--I would like the record to be clear that we did 
not rule out a proxy effect.
    Mr. Miller of California. Okay. Mr. Kreidler. You're 
grinning. You never thought I'd get to you, did you? This is my 
last question. In your written testimony, you stated that the 
use of credit scores, if it's banned, some people's--and we 
talked about this--rates would go up, and other people's would 
go down. But the FTC report's estimate that if credit-based 
insurance scores are used, more consumers would be predicted to 
have a decrease in their premiums than an increase. Would you 
like to address that?
    Mr. Kreidler. In no small part, the insurance industry has 
certainly strongly implied that credit scores are good for 
everybody. They are not. Some people go up. Some people go 
down. There is a distribution. What the proportion is of who 
benefits and who doesn't is not really the issue from my 
standpoint. It is the one that not everybody is going to be a 
beneficiary. Only so much is made from selling insurance, and 
that net profit or the premiums that are charged in order to 
remain solvent are going to be ones that will be distributed 
over the entire load.
    Mr. Miller of California. Well, thank you. I yield back. 
And now Ms. Waters has showed up.
    Chairman Watt. The gentlelady from California is 
    Ms. Waters. Thank you very much, Mr. Chairman. I'm sorry I 
could not be here earlier. This has been a very busy day with 
so many overlapping hearings going on. But this is a most 
important hearing, and I thank you for holding this hearing and 
for all of the witnesses who are here today. I thank you for 
being here.
    I am from California, and I was in the California State 
assembly for 14 years before coming to Washington, D.C., and 
for that entire period of time, I worked on redlining in 
automobile insurance. And it has been a tough and long battle 
in the State of California to get rid of redlining in 
automobile insurance.
    And it seems to me as we have begun to win this battle 
against redlining in automobile insurance, it's simply being 
charged more money based on where you live, somebody just has 
come up with another way by which to exclude and/or charge more 
money. And I don't care what is said, the information that I 
have here just basically shows that African Americans and 
Latinos, a large percentage of them--it's here someplace--are 
likely to be impacted by this policy of using FACTA scores or 
credit history as a way of determining the cost of your 
    Someone probably asked this. You probably discussed it 
already. Will someone tell me what the documented relationship 
is between your credit history and how you drive? Where is the 
empirical data that connects the two?
    Mr. Birnbaum. Well, I'll jump in and say that there is no 
data that connects the two. What the insurance industry does is 
they go into your credit history and they do a data mining 
exercise. It's a huge database, and they data mine it to see 
which characteristics are associated with claims, with people 
who are likely to renew their policy, with people who are 
likely to buy additional policies, people who are likely to be 
more profitable. Then they build a model that puts a numerical 
value on that.
    There's no theory there. There's no theory about how credit 
history relates to driving. It's a data mining exercise. And 
what you get now is a bunch of after-the-fact rationalizations 
that blame the victim. You basically say that, oh, people, you 
know, it's related to claims because people don't manage their 
finances well and they don't manage their risks well.
    Well, that's just simply not true. We know that poor people 
have to manage their finances better, because they don't have 
as much to work with. We know that the people who are penalized 
from credit scoring are the victims of economic and medical 
catastrophes. We know that the victims of credit scoring are 
people who don't have information in their files because they 
deal with payday lenders, check-cashing operations, and they 
can't get mainstream credit.
    The fact is, that there is information out there that calls 
into question the so-called correlation. And this is something 
I definitely wanted to address. When I was a regulator in 
Texas, one of the companies came in and said we want to give a 
discount to people who have been with us longer, because our 
loss ratios decline with homeowners as people who have been 
with us longer. And we said, why is that? Why do you think that 
is? Oh, we don't know, but there's a correlation.
    Well, if we had just said, okay, fine, there's a 
correlation, then we would have basically been going along with 
unfair treatment. Because when we dug a little deeper, we found 
that what they had given us was a combination of homeowners and 
renters. The renters' loss ratio was higher than the 
homeowners' loss ratio. And the percentage of the people who 
had renters insurance in the early years was greater, so the 
loss ratio was greater. So it appeared as if the longer you'd 
been with the company, the less likely you would be to have an 
accident, when in fact it was simply a function of what data 
you were looking at.
    I think that's the same thing that's happening here, is 
that there's not really any relationship between your credit 
history and the likelihood of claim. There's something being 
hidden in the data, because there are things that happen that 
are inconsistent with the theory. I mentioned that earlier 
about how delinquencies and foreclosures and debt load has 
increased over a period of time when auto claims have 
decreased. How do you jibe that with the claim that credit 
history is related to claims? No.
    Ms. Waters. Well, I think I would certainly agree with the 
analysis that you just gave. But I'd like to ask the 
Commissioner, is it Rush or Rosch?
    Mr. Rosch. It is Rosch, and I'm from California, too, 
    Ms. Waters. Good. Thank you. I asked the question about the 
correlation, and I just received an answer that makes a lot of 
sense to me. But what I want to do is I want to ask you about 
the conclusion of the Commission and what you decided to do 
about this. It says, ``The FTC therefore recently revised and 
reissued its consumer education materials, including its 
Spanish language materials, to give greater emphasis to the 
link between credit history and insurance premiums.''
    I guess that means you're counseling people that if you 
don't want to have increased premiums, you better have a better 
credit history. I mean, that's what it sounds like. ``We hope 
that these materials, this hearing, and other efforts will 
alert consumers that having the best possible credit history is 
critical not only in decisions creditors will make about them, 
but in the decisions insurance companies will make about them 
    Is that all you intend to do? I mean, do you really think 
that's credible?
    Mr. Rosch. Congresswoman, please understand that there are 
limitations on our jurisdiction that have been placed on us by 
    Ms. Waters. Well, tell us how we can undo that.
    Mr. Rosch. The McCarron-Ferguson Act delegates the power to 
regulate insurance to the States, not to the Federal Trade 
Commission. So we are embarking on--we are doing as much as we 
can do. We're not the only ones who are doing this, by the way. 
The States are also requiring the same kinds of disclosures. So 
they're reinforcing what we're doing. But we are doing as much 
as we can do within the jurisdiction that you've given us.
    Ms. Waters. But what you basically say is you believe that 
there is a correlation and that it's all right for the credit 
histories to be used to determine the premiums and how much 
money people are paying.
    Mr. Rosch. Please--
    Ms. Waters. You're agreeing with that.
    Mr. Rosch. No. No, please, Congresswoman, please--that is 
not what our report says. We take no position on whether or not 
    Ms. Waters. But you do take a position in the way that you 
have decided to handle your so-called consumer education. 
You're saying you agree. Well, this is what the insurance 
companies are doing. This is how they determine your premiums. 
Now you just make your credit histories better so that you 
won't have to be charged more money. I mean, that's the 
conclusion there.
    Mr. Rosch. We are doing as much as we can do in the real 
world today.
    Ms. Waters. Well, can you say I don't think that there's a 
correlation? I don't think that there should be a relationship 
to your credit history and the amount of money that you pay? 
That's what they're doing, but we disagree with that. Can you 
say that?
    Mr. Rosch. I can say that we do think there is a 
correlation, because that's exactly what our report to you 
shows, that there is a correlation. We are not in a position to 
say whether using that correlation to price insurance is right 
or wrong because that is a policy decision to be made currently 
by the States. But if this body decides that it should be taken 
over by the Federal Government, it is a policy decision that 
we're trying to inform you as much as we can about so that you 
can make it on a reasonable basis.
    Ms. Waters. Well, thank you very much. Mr. Chairman, I 
really do thank you. You know, I almost feel like minorities 
are under siege in so many ways. I just left a hearing about 
some bills that are being produced about gang warfare and how 
they want to create databases and identify whole communities 
as, you know, gang communities. I just got back from Jena, 
Louisiana, last week where we have a prosecuting attorney or a 
DA who has abused his power in, you know, charging young people 
who happen to be African American with criminal charges. 
Everywhere I look, it appears that there's another instance of 
really; what amounts to discrimination and abuses of power and 
that people of color are under siege in this country. And I 
don't care--I'm sure you're doing the best job you can do, Mr. 
Rosch, but whatever data that you have or whatever your 
information is that would lead you to believe that there is a 
correlation between your credit history and the way that you 
drive, it's just not believable to me. And once more, I'm going 
to end this day feeling rather offended by more information 
that causes--or undermines the quality of life for, you know, 
African Americans and people of color, whether we're talking 
about the home foreclosures or now this new way of redlining.
    So I thank you for bringing it to my attention. I just have 
to go home tonight and rededicate myself to the proposition 
that I have to do a lot of fighting. We have to confront a lot 
of issues and a lot more people. But thank you for the 
information. This hearing is extremely important.
    I yield back the balance of my time.
    Chairman Watt. The Chair notes that some members may have 
additional questions for this panel which they may wish to 
submit in writing. Without objection, the hearing record will 
remain open for 30 days for members to submit written questions 
to these witnesses and to place their responses in the record.
    I want to again applaud this panel. It has been an 
absolutely eye-opening exercise. All of you have contributed in 
very, very important ways to this very, very important 
    Mr. Miller of California. Might I say that I'd like to 
thank Mr. Schmidt and Mr. Kreidler for the sacrifice they made 
of being here today.
    Mr. Schmidt. Thank you very much, Representative.
    Chairman Watt. Especially Commissioner Schmidt.
    Mr. Schmidt. And I will be happy return to my home in 
    Chairman Watt. Thank you again for testifying, and the 
hearing is adjourned.
    [Whereupon, at 4:12 p.m., the hearing was adjourned.]

                            A P P E N D I X

                            October 2, 2007