[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
CREDIT-BASED INSURANCE
SCORES: ARE THEY FAIR?
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
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
U.S. GOVERNMENT PRINTING OFFICE
39-902 WASHINGTON : 2008
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California RICHARD H. BAKER, Louisiana
CAROLYN B. MALONEY, New York DEBORAH PRYCE, Ohio
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
GREGORY W. MEEKS, New York STEVEN C. LaTOURETTE, 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
STEPHEN F. LYNCH, Massachusetts SHELLEY MOORE CAPITO, West
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
CHRISTOPHER S. MURPHY, Connecticut MICHELE BACHMANN, Minnesota
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
MICHAEL E. CAPUANO, Massachusetts STEVEN C. LaTOURETTE, Ohio
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
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Page
Hearing held on:
October 2, 2007.............................................. 1
Appendix:
October 2, 2007.............................................. 37
WITNESSES
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
APPENDIX
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?
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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
statement.
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
sense.
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
statute.
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
insurers.
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
statement.
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
price.
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
Kreidler.
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
Army.
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
Chicago.
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.
STATEMENT OF THE HONORABLE J. THOMAS ROSCH, COMMISSIONER,
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
Gutierrez.
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
thereabouts.
STATEMENT OF THE HONORABLE J.P. SCHMIDT, COMMISSIONER OF
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
minutes.
STATEMENT OF THE HONORABLE MIKE KREIDLER, COMMISSIONER OF
INSURANCE, STATE OF WASHINGTON
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
today.
[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.
STATEMENT OF BIRNY BIRNBAUM, EXECUTIVE DIRECTOR, CENTER FOR
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
losses.
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
claims?
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.
STATEMENT OF ERIC RODRIGUEZ, DEPUTY VICE PRESIDENT, NATIONAL
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
Americans.
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
population.
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
forward.
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
statement.
STATEMENT OF NATHANIEL SHAPO, PARTNER, KATTEN MUCHIN ROSENMAN,
LLP
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
codes.
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,
discriminatory.
``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
drivers.''
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
responsible.
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
skills.
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
classification.
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
framework.
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
discussion.
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
history?
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
hand.
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
doing.
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
correct?
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
corrected.
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
way?
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
here.
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
experience.
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
result.
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
that.
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.
[Laughter]
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.
[Laughter]
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
Congress.
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
suggesting--
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
this?
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
factors.
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
charge.
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
them?
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.
Rosch--
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
recognized.
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
insurance.
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,
Congresswoman.
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
too.''
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
Congress.
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
that--
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
discussion.
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
Hawaii.
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
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