PDF CREDIT-BASED INSURANCE SCORES

[Pages:242]CREDIT-BASED INSURANCE SCORES:

IMPACTS ON CONSUMERS OF AUTOMOBILE INSURANCE

A Report to Congress by the Federal Trade Commission

July 2007

FEDERAL TRADE COMMISSION

Deborah Platt Majoras Pamela Jones Harbour Jon Leibowitz William E. Kovacic J. Thomas Rosch

Chairman Commissioner Commissioner Commissioner Commissioner

Bureau of Economics

Michael R. Baye Paul A. Pautler Jesse B. Leary

Director Deputy Director for Consumer Protection Assistant Director, Division of Consumer Protection

Bureau of Consumer Protection

Lydia B. Parnes Mary Beth Richards Peggy Twohig Thomas B. Pahl

Director Deputy Director Associate Director, Division of Financial Practices Assistant Director, Division of Financial Practices

Analysis Team

Matias Barenstein, Economist, Bureau of Economics, Div. of Consumer Protection Archan Ruparel, Research Analyst, Bureau of Economics, Div. of Consumer Protection Raymond K. Thompson, Research Analyst, Bureau of Economics, Div. of Consumer Protection

Other Contributors

Erik W. Durbin, Dept. Assistant Director, Bureau of Economics, Div. of Consumer Protection Christopher R. Kelley, Research Analyst, Bureau of Economics, Div. of Consumer Protection Kenneth H. Kelly, Economist, Bureau of Economics, Div. of Consumer Protection Michael J. Pickford, Research Analyst, Bureau of Economics, Div. of Consumer Protection W. Russell Porter, Economist, Bureau of Economics, Div. of Consumer Protection

TABLE OF CONTENTS

i

LIST OF TABLES

iii

LIST OF FIGURES

iv

I. EXECUTIVE SUMMARY

1

II. INTRODUCTION

5

III. DEVELOPMENT AND USE OF CREDIT-BASED INSURANCE SCORES 7

A. Background and Historical Experience

7

B. Development of Credit-Based Insurance Scores

12

C. Use of Credit-Based Insurance Scores

15

D. State Restrictions on Scores

17

IV. THE RELATIONSHIP BETWEEN CREDIT HISTORY AND RISK

20

A. Correlation Between Credit History and Risk

20

1. Prior Research

20

2. Commission Research

23

a. FTC Database

23

b. Other Data Sources

28

B. Potential Causal Link between Scores and Risk

30

V. EFFECT OF CREDIT-BASED INSURANCE SCORES ON PRICE

AND AVAILABILITY

34

A. Credit-Based Insurance Scores and Cross-Subsidization

35

1. Possible Impact on Car Ownership

39

2. Possible Impact on Uninsured Driving

40

3. Adverse Selection

42

B. Other Possible Effects of Credit-Based Insurance Scores

46

C. Effects on Residual Markets for Automobile Insurance

49

VI. EFFECTS OF SCORES ON PROTECTED CLASSES OF CONSUMERS

50

A. Credit- Based Insurance Scores and Racial, Ethnic, and Income Groups 51

1. Difference in Scores Across Groups

51

2. Possible Reasons for Differences in Scores Across Groups

56

3. Impact of Differences in Scores on Premiums Paid

58

a. Effect on Those for Whom Scores Were Available

58

b. Effect on Those for Whom Scores Were Not Available

59

B. Scores as a Proxy for Race and Ethnicity

61

1. Do Scores Act Solely as a Proxy for Race, Ethnicity, or Income? 62

2. Differences in Average Risk by Race, Ethnicity, and Income

64

3. Controlling for Race, Ethnicity, and Income to Test for a Proxy Effect 67

a. Existence of a Proxy Effect

67

b. Magnitude of a Proxy Effect

69

i

VII. ALTERNATE SCORING MODELS

73

A. The FTC Baseline Model

74

B. Alternative Scoring Models

78

1. "Race Neutral" Scoring Models

78

2. Model Discounting Variables with Large Differences by Race and

Ethnicity

80

VIII. CONCLUSION

82

TABLES FIGURES APPENDIX A. APPENDIX B. APPENDIX C. APPENDIX D. APPENDIX E. APPENDIX F.

Text of Section 215 of the FACT ACT Requests for Public Comment The Automobile Policy Database Modeling and Analysis Details The Score Building Procedure Robustness Checks and Limitations of the Analysis

ii

TABLES

TABLE 1. Typical Information Used in Credit-Based Insurance Scoring Models

TABLE 2. Claim Frequency, Claim Severity, and Average Total Amount Paid on Claims

TABLE 3. Median Income and Age, and Gender Make-Up, by Race and Ethnicity

TABLE 4. Change in Predicted Amount Paid on Claims from Using Credit-Based Insurance Scores, by Race and Ethnicity

TABLE 5. Estimated Relative Amount Paid on Claims, by Race, Ethnicity, and Neighborhood Income

TABLE 6. Estimated Relative Amount Paid on Claims, by Score Decile, Race, Ethnicity, and Neighborhood Income

TABLE 7.

Change in Predicted Amount Paid on Claims from Using Credit-Based Insurance Scores Without and With Controls for Race, Ethnicity, and Income, by Race and Ethnicity

TABLE 8.

Change in Predicted Amount Paid on Claims from Using Other Risk Variables, Without and With Controls for Race, Ethnicity, and Income, by Race and Ethnicity

TABLE 9. Baseline Credit-Based Insurance Scoring Model Developed by the FTC

TABLE 10. Credit-Based Insurance Scoring Model Developed by the FTC by Including Controls for Race, Ethnicity, and Neighborhood Income in the Score-Building Process

TABLE 11. Credit-Based Insurance Scoring Model Developed by the FTC Using a Sample of Only Non-Hispanic White Insurance Customers

TABLE 12. Credit-Based Insurance Scoring Model Developed by the FTC by Discounting Variables with Large Differences Across Racial and Ethnic Groups

iii

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