HANDYMAN 
Biggest Factor in Getting Some Drivers Affordable Coverage
A report released last month by the R Street Institute ranking state insurance departments on their regulatory systems claims that credit scoring has been “the biggest factor” in getting drivers out of state-run high-risk pools and back into the open coverage market, where prices are much more affordable.
The R Street Institute—a spin-off of the Heartland Institute that supports “free markets” and “limited effective government”—docked points from states that limit or completely prohibit insurers from basing rates partially on a driver’s financial history. R Street says insurance companies should have extremely wide latitude to set rates in order for the free market to regulate competitiveness.
Why Credit?
Credit scoring, also known as insurance scoring, is when insurers look at an applicant’s financial history in order to see what it might tell them about how good of a driver that applicant is. Why do insurers believe that things like bankruptcies, credit history, and debt ratios would be able to tell them how good of a driver an applicant is? Claims statistics and independent studies have shown that the worse of a financial history you have, the worse of a driver you’re likely to be.
An 82-page report issued by the Federal Trade Commission (FTC) in 2007 on the use of consumers’ financial information in auto and home coverage markets concluded that credit-based insurance scores “are predictive of the number of claims consumers file and the total cost of those claims.” In the FTC report, an analysis of data for claims in which policyholders damaged another person’s property showed that insurers paid out nearly twice as much for the group with the lowest scores when compared with the group with the highest scores.
“The use of scores is therefore likely to make the price of insurance better match the risk of loss posed by the consumer,” the FTC wrote. “Thus, on average, higher-risk consumers will pay higher premiums and lower-risk consumers will pay lower premiums.”
And according to the R Street Institute, that’s exactly what has happened
Credit Scores and Residual Markets
Specifically, they say that financial scoring has been the driving factor in depopulating states’ residual markets, which are state-run markets of last resort for high-risk drivers. These pools consist of drivers that appear too risky to insure profitably. When drivers enroll in these pools, they are assigned to a carrier. The policies cost more this way, but, for hundreds of thousands of people, it’s the only option.
But by allowing credit scoring, the R Street Institute argues, insurers are much better able to accurately price policies. So people who looked to be too risky to insure on paper may not look so bad once you get a peek at their financial history, and they have better access to affordable car insurance as a result.
And R Street is correct about the fact that residual markets are shrinking. Data from AIPSO, the organization that helps states run their residual markets, backs up their conclusion. The number of policies issued through state residual markets in the U.S. annually fell by about 27 percent between 2005 and 2009, falling from about 2.37 million to about 1.73 million.
However, it’s not clear how much of that trend could be attributed to the use of credit scores. Consider the fact that California and Massachusetts both saw huge drops in residual-market enrollment between 2005 and 2009, yet these are two of the only three states (the other is Hawaii) that ban the use of credit scoring. California cut its residual-market enrollment by a whopping 90 percent during that period, and Massachusetts cut its enrollment by 56 percent. Credit scoring had nothing to do with those gains.
In the end, R Street gave everyone neutral scores on credit scoring except for the states that have an outright ban on the practice. Hawaii, Massachusetts, and California all got docked points for their regulations.
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