The dispute over the use of credit reports has its genesis in a 2003 bill where lawmakers first set out a detailed law to regulate the use of credit reports when it comes to calculating a policyholder's premiums. The law was primarily based on a 2003 report issued by the National Association of Insurance Commissioners entitled “Credit-Based Insurance Scoring: Regulatory Options.”

The 2003 law was designed to place some restrictions on the use of credit scores while preserving the rights of carriers to factor in some information when considering a prospective policyholder's application for coverage. Much of the law and the rule follow the federal Fair Credit Reporting Act that is aimed at curbing the use of credit reports and makes the methodology behind their use more transparent. For example, the law included a “no hit” provision whereby an insurer could not use a credit report to non-renew a policy, increase a policyholder's premiums, or refuse to place them in the lowest bracket of insurance they would otherwise qualify for based on the following conditions: the absence of a credit history, liens against the policyholders for medical treatments, place of residence, or other circumstances as set out by the FSC.

Additionally, insurers were required to inform a prospective policyholder that the insurer is using a credit report when reviewing their application for coverage. If the consumer is rejected based on the credit report, the insurer must provide the consumer with a copy of the report. Consumers could appeal the decision if they provide the insurer with a reasonable documentation showing a temporary loss of employment, dissolution of marriage, or death of a spouse. Carriers are also required to undergo a periodic review of a policyholder's credit report to see if any changes would impact the policyholder's rates.

Property Casualty Insurers Association of Insurance representative William Stander said that while the industry would have preferred there be no legislation on the issue, the industry negotiated in good faith with the belief that insurers could still use credit reports. “We believed, most importantly, that we retained the right to use credit reports with some restrictions,” he said. “That belief was challenged when the OIR put into place a rule that would have had the effect of preventing the use of credit reports.”

Bad Blood

As is often the case, while the statute seemed self explanatory, lawmakers had their own view on how it should be implemented. As a result, the rule-making process quickly bogged down with both the industry and regulators accusing each other of not acting in good faith. The bad blood started in October 2003, when the OIR issued a draft rule that the industry argued was crafted to, in effect, make sure that carriers couldn't use credit reports. For example, the industry representatives said the requirement that carriers prove rates are fair based on the policyholders' place of residence is outside carriers' purview since they don't collect the demographic information.

From the industry's point of view, the draft rule reflected what the industry termed a bias on the part of some regulators against the use of credit reports. “Some people in the OIR were virulently opposed to the use of credit scoring regardless of what the law said,” remarked Stander. The next two-and-a-half years witnessed a series of regulatory actions in the form of rule workshops and hearings, where regulators kept pushing for a rule while the industry appeared intent on stopping them. OIR General Counsel Steven Parton said by challenging the statutory authority of the OIR to promulgate the rule, he realized the industry had no desire to reach an agreement on the rule. “We could have had a rule challenge a year ago,” he said. “Here we are a year later and the industry has repeatedly asked for delays. Clearly, they have no intention for this rule to be heard.”

Parton was referencing a 2005 rule challenge filed by PCIA, the Florida Insurance Council, the American Insurance Association, and the National Association of Mutual Insurance Companies, against the OIR, the Department of Financial Services, and the Financial Services Commission. In that challenge, the industry argued that due to the reorganization of the former Department of Insurance the OIR no longer had the statutory ability to promulgate a rule on credit scoring.

A Controversial Move

With the negotiations between the industry and regulators deadlocked, the FSC moved forward and approved two parts of the rule governing the use of credit scores. The move was highly controversial, not least of all because the state generally doesn't intercede in a matter that is in litigation. In this case, however, regulators took the position that the use of credit reports could have a negative impact on consumers and therefore some protection should be put in place to prevent that from happening.

As stated in the May 2006 memo from the OIR to all carriers, “In light of the delays associated with the ongoing litigation and the potential harm to consumers resulting from the use of credit reports and credit scores, the FSC has authorized the OIR to begin implementation of the provisions of the rule.” The FSC signed off on the rule (Rule 69O-125.005) that contained two major provisions. They are as follows:

Beginning September 1, 2006, all Florida property and casualty insurers making a new rate, rule, or underwriting guideline filing that uses, is in anyway subject to, or is based upon, credit reports or credit scores, will be required to demonstrate that their credit scoring methodology does not disproportionately affect persons of any race, color, religion, marital status, age, gender, income, national origin, or place of residence.

By December 1, 2006, all Florida property and casualty insurers that use credit reports or credit scores for rates, rules, or underwriting purposes are required to provide appropriate information sufficient to demonstrate that their credit scoring methodology does not disproportionately affect persons of any race, color, religion, marital status, age, gender, income, national origin, of place of residence.

A Court Battle

When it comes to rules, the axiom is, when in doubt hire a lawyer, which is exactly what the industry trade groups did. The industry's rule challenge centered on two points. First, the industry questioned whether the OIR violated the Administrative Procedure Act by implementing the rule. Under the act, state agencies cannot issue rules unless they are tied to a specific statutory provision. From the regulators' point of view, the state had that authority under Chapter 626.9741(8), Florida Statutes. The law gives the FSC the green light to adopt rules governing the use of credit reports. Specifically, the rule may include the following:

Information that must be included in filings to demonstrate compliance with Chapter 626.9741(3), which requires carriers to inform a prospective policyholder if their credit report impacts their premiums.

Statistical information that must be submitted to OIR if an insurer uses credit reports when determining a policyholder's premiums.

Standards that ensure that rates or premiums associated with the use of a credit score are not unfairly discriminatory based on race, color, religion, marital status, income, national origin, or place of residence.

Standards for review of models, methods, programs, or any other process by which to grade or rank credit report data and which may produce credit scores in order to ensure that the insurer demonstrates that such grading, ranking, or scoring is valid in predicting insurance risk of an applicant or insured.

Judge Stevenson didn't rule that the FSC and the OIR don't have the authority to issue a rule on the use of credit scoring, a decision that was greeted positively with regulators. “After reviewing the decision, I am pleased the administrative law judge agreed that the governor and Cabinet do have the authority to prohibit the use of credit scoring if it unfairly discriminates, and that he disagreed with the claim of the petitioners that we did not have the authority to define unfair discrimination in anything other than actuarial terms,” said Insurance Commissioner Kevin McCarty.

While McCarty stood by Stevenson's position on the state's regulatory authority to issue a rule, the industry was focused on a more central issue. Namely, that neither the statute nor rule defines what constitutes “unfair discrimination” or how to determine whether a class of individuals suffered a “disparate impact” by the use of credit reports with respect to race, martial status, age, and other factors. Without those crucial definitions, any attempt to issue a rule appears to be moot. McCarty, however, is far from throwing in to towel on the issue.

“We respectfully disagree with the judge's deeming of the definition unfairly discriminatory as vague and not adequately defined in the rule. However, he has made certain suggestions in this regard which we will review and may incorporate into the rule,” McCarty said. “This guidance by the judge may also be useful in an appeal of other issues regarding the challenges to the rule that we believe need to be remedied.”

As for the industry, it is now awaiting how newly elected Chief Financial Officer Alex Sink will approach the issue. It remains to be seen how much of a priority the issue is to her, especially given the current insurance agenda that is focused so heavily on homeowners' insurance.

A National Debate

FIC's Marvin states that the impact of Judge Stevenson's ruling could have national consequences. Florida is not alone in its quest to regulate the use of credit reports. Delaware, Colorado, Minnesota, New Mexico, Michigan, and Washington State are all in the process of either drafting laws or rules governing the use of credit scores. In the recent general election, Oregon voters overwhelmingly rejected a constitutional ban that would have prevented insurers' from using credit reports.

Depending on one's point of view, credit scoring is either an institutional method to discriminate against certain classes of policyholders or is an important piece of the puzzle to ensure that individual rates adequately reflected the risk. From the industry's point of view, the use of credit reports has become a key indicator of a policyholder's claim record. An Insurance Information Institute white paper makes the case that credit reports indirectly provide a more realistic picture of a consumer's potential behavior.

As noted in the study, “The character trait that leads to careful money management seems to show up in other daily situations in which people have to make decisions about how to act, such as driving. People who manage money more carefully may be more likely to have their car serviced at appropriate times and may also more effectively manage the most importance financial asset most Americas own, their house.”

Proof in the Patterns

A study commissioned by the State of Texas, conducted by the University of Texas Bureau of Business Research, studied 150,000 policies from the top five insurers providing coverage in the state. When matching the claims data to the credit scores, researchers found that those drivers with lower scores had slightly higher claims costs. Claims costs for drivers with poor credit reports average $918, which is 53 percent higher that expected. Those drivers with higher scores reported losses of $558, which was some 25 percent lower than average.

More specifically, the Texas report found that the average loss per vehicle among drivers with poor credit records was double that of people with the best scores. And drivers with the best credit were involved in about 40 percent few accidents. The same pattern held true with regards to homeowners' insurance, where the loss ratio for people with lower credit scores are triple that of people with the best scores. For Parton, however, that study still begs the question of who is penalized by the use of credit scores. “When you look at credit scoring you can't help but come to the conclusion that people with low incomes or groups like African-Americans are having to pay higher premiums,” he said.

The I.I.I. report also made two other points. First, given the flow of information in the electronic age, the access to and use of credit reports is only going to increase. Likewise, computer models employed by carriers that include factors for credit scoring are going to get more and more sophisticated. Even so, the I.I.I. maintains that too much of the emphasis on the use of credit scores is painted in the negative when it truth it does help stabilize rates for auto and homeowner policyholders. As noted in the report, “Many people have not idea that they are beneficiaries of credit scoring. Two-thirds of policyholders have a lower premium because of good credit, insurers say, although consumers themselves think most people do not benefit.”