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BY: Consumer Reports, 11/22/11

Known as credit-based insurance scores, these numbers are computed from bill-paying and loan data collected by the major credit bureaus. In recent years, the scores have become as important in determining your annual premium as your driving record and the neighborhood where you live.

An analysis by Consumer Reports found that scoring could cost many consumers hundreds of extra dollars. Here's a typical example of how scores can hurt: a 28-year-old single male from  Orlando, Fla., with a clean driving record and no accidents would normally pay State Farm Mutual $1,251 a year for a new policy. With one at-fault accident, his premium would rise to $1,447. If the same driver instead fell into the lowest ranking in State Farm's credit-scoring system, however, his premium would shoot up to $2,600.

Even a driver with a great credit score whom lenders would normally bless with a low-interest mortgage could wind up with a less favorable insurance score and thus a high premium. That's because formulations for insurance scores weigh credit data differently from traditional lender scores. Indeed, insurance scores can penalize consumers who use credit reasonably. For instance, Progressive Auto Pro's Financial Responsibility Score will give premium-boosting black marks to a customer whose credit-bureau information says he opened three credit accounts within the previous year, including one credit card in the previous four months, and then made two or more additional loan inquiries without accepting the credit.

Such a system may seem bizarre, but insurers contend that there is method to their math. Because there is a statistical correlation between scores and claims, scoring "shifts costs from drivers who file fewer claims to those who file more," says Robert Hartwig, chief economist for the Insurance Information Institute, an industry trade association.

Insurance officials say that most consumers are paying lower premiums more precisely related to risk. "Before, there were only a few rating tiers," says Keith Toney, president of InsurQuote, a division of ChoicePoint, an Alpharetta, Ga., provider of insurance scores. "Credit scoring allows companies to sort customers into hundreds of tiers."

Even though scoring has been in use for more than a decade, it is a mystery to most consumers. About two-thirds of 1,578 consumers surveyed for a report last year by the Government Accountability Office did not know that their credit histories could affect their insurance premiums.

And how could they know? Few insurers routinely disclose scores or what role they play in setting premiums. To fill that void, Consumer Reports sought and obtained scoring models filed with regulators in Florida, Michigan, and Texas used by 9 of the 10 largest U.S. auto insurers. Then, with the help of experts, we deciphered the cryptic wording and algorithms that affect the price of insurance.

What we found was a mishmash. Hundreds of insurers use scoring models created by ChoicePoint and Fair Isaac, the Minneapolis company that invented credit scoring. Other insurers developed their own systems. The scoring models emphasize bits of credit data that to the average person would seem to have little to do with a driver's propensity to make claims. There are no standards: Each company uses different models and weighs different credit-report information. Some big companies find scoring useful only for new customers, not renewals, while others may use it for both.

Moreover, the credit data from which the scores are derived have a reputation for being inaccurate and out of date. And several studies have shown that insurance scoring adversely affects blacks, Hispanics, and low-income consumers. Despite such problems, most states allow insurance scoring, and efforts to limit or ban it have been met with aggressive lobbying by insurers.

SCORING: FACTS AND FICTION

Insurers have long used statistics to determine premiums. That's how they figured out that drivers under age 25 have more accidents than older drivers. The traditional rating factors have been age, sex, marital status, ZIP code, driving record, and three-year history of at-fault accidents. Insurers determine how much each factor affects the frequency and size of payouts and create a formula for calculating a premium based on your characteristics. The formula starts with a dollar base rate for each type of coverage, then multiplies, adds, or subtracts amounts based on each of the rating factors.

In the 1990s, Fair Isaac worked with several insurers to test its theory that credit scores might predict homeowners- and auto-insurance claims losses. Statistical analysis of archived data from more than a million credit files found that 30 of 100 or so items in the reports correlated with payouts. That finding led to the creation of homeowners- and auto-insurance scores.

A study conducted in 2000 by James Monaghan, a research strategist at Metropolitan Property and Casualty Insurance Company, found, for example, that people whose oldest account on their credit report dated back 25 to 29 years subsequently filed only $60 worth of claims for every $100 of premiums paid over the next three years. But people whose oldest account was only a year old filed $95 in claims per $100 of premiums over the ensuing three years.

Neither insurers nor the credit-scoring companies that discovered the relationship know what causes it, except to suggest that those with subpar credit are themselves subpar. "People with a pattern of irresponsible financial behavior and poor credit history have a much greater chance of being in an accident or filing a claim," says Joseph Annotti, a spokesman for the Property Casualty Insurers Association of America, a trade group. The American Academy of Actuaries said in its 2004 recommendations to the Federal Trade Commission that "aggressiveness" and "willingness to take risks" go along with a poor driving record. "The correlation with fraud is striking," says Gordon Stewart, president of the Insurance Information Institute. But the Monaghan study, which reviewed those long-standing inferences, says that links between responsible financial management and future expected losses are "unsupported."

Steven Parton, general counsel for the Florida Office of Insurance Regulation, says, "What they're really looking to see with insurance scores is who is most likely to file a claim, not who will most likely have an accident. If I have the money, I won't file a claim, because my rates will go up. People of low economic status don't have that luxury." Parton adds, "Insurance companies are looking at whether they're relying on their insurance in case they have an accident, which is what they're buying insurance for to begin with."

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