When Elizabeth Alexander opened a letter from her auto insurer, Pemco, last January, she got a nasty shock. Her rates had been raised by 33%, from $1,200 to $1,600 per year. The increase was a surprise because neither Alexander nor her husband, Larry Jackson, had been in an accident or placed a claim at any time during their six years with Pemco. Outraged, the Kirkland (Wash.) couple called around to a few other insurance companies to try to get a better rate. But the competition's rates were even higher.
The reason? Jackson's credit status. Last year, he had a dispute with his bank over a student loan, which led to a black mark on his record -- and the subsequent rate hike on the couple's auto insurance. Such decisions are anything but unusual. According to Conning & Co., a Hartford (Conn.) research firm, 92% of insurers use credit scores as a factor to grant policies and set rates.
"I've been driving since I was 17. Now I'm 42, and I've never had a claim against me," says Alexander, a program manager at Microsoft. "Not-so-perfect credit doesn't mean I'm a bad driver. In fact, all the evidence shows that I'm a good driver."
LEGAL RESPONSE. Alexander isn't alone. Since January, 2001, hundreds of Washington State residents have complained to the state insurance commissioner that their rates were being unjustly hiked. In response, the state House and Senate overwhelmingly passed bills to prevent insurers from using a consumer's credit score to cancel or not renew personal-insurance policies. The bills also outlaw the use of six factors, including the number of credit inquires and the consumer's available line of credit, in assessing policies and rates. Washington Governor Gary Locke signed the bill into law on Apr. 4.
The issue is fast becoming one of the hottest topics in state legislatures across the country. Hawaii and Connecticut have also passed legislation aimed at curbing the use of credit scores in insurance underwriting, and 21 more states have bills pending.
At the center of the storm is little-known California company Fair Isaac (FIC
), number 50 on the S&P SmallCap 600. Fair Isaac creates the credit scores, known as FICO scores, that tell lenders whether a consumer is a good credit risk. Scores range anywhere from 300 to 850. The higher the score, the better the credit risk. A consumer with a FICO score of 700 will pay approximately $382 per month for a $20,000 auto loan over 60 months, according to E-LOAN, a California-based Internet lending institution. The same loan for someone with a score of 680 costs $393, while a borrower with a FICO of 580 will pony up $495.
"SUBJECTIVE GUESSWORK." Just what goes into a consumer's score is anyone's guess -- because Fair Isaac isn't telling. The company maintains that its formula, which is used by the vast majority of lenders and 380 insurance companies, is proprietary. According to Fair Isaac spokesman Craig Watts, the algorithm must be protected so that consumers do not artificially inflate scores in the short term to, say, get a cheap loan and then return to their former profligate ways.
And therein lies the problem. "The word 'score' implies that something empirical is being measured, like body-fat percentage or cholesterol," says privacy-rights consultant David Holtzman. "In fact, FICO-like scores are based on highly subjective guesswork that might be offensive and possibly legally actionable if they came from a human being instead of a computer." As data profiling becomes more common, expect Fair Isaac's power -- and the consumer outcry about its secrecy -- to grow.
The insurance hubbub isn't Fair Isaac's first run-in with privacy advocates. In September, 2000, it was hauled in before a congressional subcommittee to explain why consumers don't have access to their FICO scores. This came after Fair Isaac pressured E-LOAN to stop making client FICO scores available free of charge.
PARTIAL PEEKS. Fair Isaac claimed the service was misleading because it presented the scores out of context. But E-LOAN CEO Christopher Larsen says that's absurd: "Our model is to help consumers manage their debt just as they manage their stock portfolio. That makes understanding and managing FICO scores the cornerstone of our business."
As a result of the hearings, Fair Isaac is becoming more consumer-friendly. Last year, it launched a Web site called myfico.com that allows consumers access to their credit report and FICO score for a fee of $12.95. Next month, Fair Isaac will launch a simulator to help consumers figure out how to improve their scores -- something the company had previously claimed was impossible to do. For instance, the site will tell consumers how opening a new credit-card account or paying down some debt will affect their FICO score.
Fair Isaac's move toward what it calls consumer-empowerment services aren't motivated solely by good will. Company CEO Thomas Grudnowski estimates that industrywide revenues from the consumer business will one day total $500 million to $1 billion a year, vs. very little now. "A year ago, no one at Fair Isaac would say that consumer business would be a big part of the business. Now, the answer is maybe," says spokesman Watts.
TEMPLE EDICTS. Consumer advocates say these efforts don't go far enough. Larsen and others argue that a federal law is needed that gives consumers the right to a free copy of their credit score -- as well as a detailed explanation of how the score is computed. "Fair Isaac wants to be the high priest in the temple and issue edicts without anyone understanding what's going on," says Edmund Mierswinski, a consumer-credit expert with the Ralph Nader-affiliated U.S. Public Interest Research Group. "We need to know how the scores work. We need to know if they're accurate. We need to know if they're discriminatory."
That's even more important when the score is used to make decisions about issues like insurance, which are less closely tied to credit history -- if at all. "They need to make it transparent -- to remove the secrecy so that the public has an idea how [the information is] being used," says Washington Insurance Commissioner Mike Kreidler, who led the charge to pass the state's new law. "That would ease the problems of outright unfairness we found, as well as the perception of unfairness." A simple solution to a growing problem.
APRIL 4, 2002
Black covers privacy issues for BusinessWeek Online. Follow her twice-monthly Privacy Matters column, only on BusinessWeek Online Edited By Douglas Harbrecht
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