Credit Scores, a Scarlet Letter?

Posted by: Jessica Silver-Greenberg on June 17

Don’t forget to pay your credit card bill on time, and certainly don’t let that electric bill languish because delinquent payments could imperil your ability to get insurance. Yep, that’s right. A number of auto and home insurance companies use your credit score, held by credit bureaus like Fair Isaac and TransUnion, to determine insurance premiums. Lackluster credit scores, checkered by late-payments or discharged bills, could translate into higher insurance rates. Although the process is pretty opaque, insurers tend to rely on a number of factors including credit behavior, driving records, and mortgage payments, to churn out insurance premiums.

Even in headier times before the economy tanked and unemployment starting creeping towards double digits, the use of credit score rankled consumer rights advocates who claimed that insurance credit scoring discriminated against lower-income people. Some civil rights activists say that credit scores could become a proxy to discriminate on the basis of race, gender or ethnicity. But now, advocates are even more concerned because they believe that as credit scores fall during a recession, insurance rates will edge even higher and impact the newly unemployed drivers. They want to ban the use of credit scoring in calculating insurance premiums across all states. Already California, Massachusetts and Hawaii have outlawed the practice.

The Wall Street Journal reported that credit scores actually haven’t deteriorated like consumer groups worry. That hasn’t stemmed the call for the ban. Back in 2007, calls for change were heightened when the Federal Trade Commission found that African American and Hispanic drivers end up paying much more for auto-insurance due to the use of credit scores.

Aside from the implications on insurance premiums, I think that the use of credit scores suggests a growing reliance on granular data by all kinds of lenders whether it be insurance companies, credit card issuers or mortgage brokers to determine risk. The subprime crisis that saw large swaths of homeowners unable to make even the minimum mortgage payments put a spotlight on the problem of assessing risk. Now that lenders are skittish and fortifying underwriting standards, they are likely to turn to all kinds of data including marital status, shopping patterns, and geographic location. The privacy implications could prove huge, and the question is whether any of this data is an accurate proxy to judge ability and likelihood that a consumer will repay.

Reader Comments

dw

June 17, 2009 04:31 PM

the biggest problem with using the credit score is this. GIGO (for those who don't know Garbage in, garbage out). the scores are based on shall we say, less than accurate information, and in fact are not much better than rumors on occasion. without some real verifying the information is correct, its like using a speedometer that is frozen (like a certain aircraft recently in the news) to determine whether you are going to fast or to slow

Norm Magnuson

June 18, 2009 09:27 AM

In response to DW, the Fed, GAO and others have dispelled the notion that credit report information is not accurate. Additionally, the credit reporting industry testified before Congress that of 52 million consumers who received their reports, less than 2% resulted in a dispute in which information was deleted. Empirical data like this attests to the fact that credit reports are accurate.

Assad

June 19, 2009 06:58 PM

Norm, your conclusion is based on data the credit reporting industry provided regarding its own performance. For years the tobacco industry determined there was no link between their products and cancer - which they supported with data/research as well.

Maybe you should take up smoking?

My credit report has been riddled with blatant errors and inaccuracies. Two percent is a gross underestimate.

The growing dependence on such a flawed system by an ever expanding number of industries is cause for concern. It threatens not only consumers but one of our core American values - privacy.

randall ferguson

June 20, 2009 02:27 PM

"additionally, the credit reporting industry testified before congress"...oh, no vested interest there...sheeesh...regards

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BusinessWeek's Adrienne Carter, Jessica Silver-Greenberg, and David Henry deconstruct the mysteries of high finance, Wall Street, and hedge funds for pros and ordinary investors. E-mail them directly if you've got tips about big deals, a hedge fund, or even securities industry gossip.

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