concerning oregon's measure 42...

Whenever I see a new measure/initiative/referendum I always find it fascinating to look a little deeper and see what the real impact of the law since sending issues directly to the voters often is a ploy to sneak something in that sounds good but would never pass muster if reviewed by intelligent, conscientious lawmakers (yes I am aware I am giving them perhaps too much credit, but I still believe generally they have our best interests at heart).

So recently I have noticed that Oregon's measure 42 has been had virtually no advertising in favor, only against. Obviously the insurance industry is behind the campaigns against outlawing a practice they spent a lot of time and money to create, but who is behind the measure itself? I will admit I didn't dig enough to learn that little nugget, but I did do a lot of reading on this blog from someone who seems to be an insurance industry insider who offers mostly favorable information about "insurance scoring," who benefits and what supposed effects it has as a whole.

One of the reasons I chose to look into this issue (after all, I am not an Oregon resident) is because of the claims in the anti-measure 42 ads that "60-70% of Oregon residents have good credit and save money on their insurance because of it."

On Mike's blog I found a chart he says is representative of one of the only major academic studies about using credit scores as a predictor of exposure to a loss. This information seems to match up with the claims in the ads since only the bottom 30^th percentile have significantly higher risk for a loss. Now the chart does not say how long a period was covered in the study or the ultimate cost of the loss over time. Perhaps a better chart would be more three dimensional and demonstrate, based on credit score percentile, the risk and cost of losses in each group. This would certainly be more informative and ultimately help them in their pricing I would think, but they chart only refers to an "average relative loss rate."

Now since I am somewhat good at math and statistical analysis, I can help break down the chart for you as well as he did if you do not care to read his post. The bottom 30^th percentile represents significantly higher risk to the insurance company. The next 30 percent represent average risk. Actually the chart says lower than average, but in the world of statistics, there is always a margin of error, so 0.99 can easily be rounded up to 1.0. So the 30-60^th percentile represents normal risk statistically. It is only then the top 40 percentile that reduces the insurance company's exposure to loss and progressively so.

However, I would argue that the degree to which the top 40^th percentile "save the insurance company's money" is negligible compared to the degree to which the bottom 30^th percentile cost them money. Obviously this is because there are 33% more people in this category and by the most basic rules of statistics the three groups must balance each other out.

So back the claim in the advertising that 60-70% of Oregon residents save money because of "good credit." I believe this to be a false statement for two reasons. First whether credit is defined as "good" or "bad" is a matter of comparison to the peer group. So you can only truthfully say that 49.99% of people in a given group have "good" credit. However, they are trying to defeat a ballot initiative so it wouldn't help them to claim that 50% of people have good credit. Also, working in the mortgage industry, I know that people tend to have a perception that their credit is worse than it is. I would say the better a person's credit is, the more likely they are to KNOW they have good credit; however this only seems to manifest itself in the highest percentiles. Those in the middle 40 percent I would propose are generally pessimistic about their credit and the major reason for this is that it fluctuates constantly based on a number of factors that the 3 major credit bureaus do not want the public to be entirely aware of (they keep their credit scoring systems secret as intellectual property). So ask yourself; how good do you think your credit is. Do you think it is good? Why or why not?

The second reason I believe the statement in the advertising to be false is that the stats on Mike's blog indicate that there is a large portion of this 70% whose credit/risk correlation is marginal. If the insurance companies are using this model they would only offer "discounts" to the top 40% and issue policies under some kind of sub-prime rate structure that would have to have been developed after the model was introduced to the bottom 30%.

Mike also address' the claim that this system is only designed to punish or "screw" customers with bad credit. He counters by saying no such attitude exists in the insurance industry, they are merely trying to develop risk exposure structures to compete better in the market, offering better discounts to draw customers away from other insurance companies.

The problem I have with this logic is that the more widespread these matrixes become, the more difficult it would be for someone with bad credit to get a preferred rate, from ANY insurance company, regardless of the lack of history of accidents or traffic violations because these models give so much weight to so-called predictive data.

So I agree that the insurance companies are not trying to screw poor people or people with bad credit or even minorities, however I do believe they have introduced a system that unfairly discriminates on persons based on their association with groups believed to present the insurance company with a higher risk exposure.

The reason the insurance companies feel they need to know someone's credit information to give them a policy quote? Well, they say it is because there is no way to determine a person's driving behavior, for example (when quoting automobile policies). Historically insurance companies have charged higher rates to younger drivers due to their lack of experience and driving history. The truth is there are ways to analyze a persons risk and they are to document previous claims and to periodically pull their driving record from the state their license is issued. They already do use this information when quoting or reissuing policies.

So if a person has held a drivers license for 10 years and there are no traffic violations and accidents, why should their credit be used when issuing a policy if they only purpose is to determine future risk? Someone with a clean driving record (though perhaps with poor credit) should be assumed to be of little risk.

When offering policies to young people without sufficient driving history to evaluate risk, they should charge more (and do) without regard for credit history (which will also provide only a limited amount of information for someone who is younger and hasn't had time to build credit).

The only remaining problem I have with the logic of the commercials against measure 42 is that they drive into voters watching these commercials that by passing the law and making it illegal to use credit scores as a discriminator when quoting insurance rates will result in the subsidizing of those with bad credit by those with good credit. Again, I believe they are wrong when they say that 60-70% of people will see rate hikes (unless the insurance companies collectively wage war in Oregon to try to overturn the law) since only 40% of insurees present a significant risk-exposure benefit to warrant any discount in the first place. Yet I also want to point out that even the insurance industry sells these policies as "discounted" due to favorable credit.

I receive lots of discounts from my auto insurance company (credit score not being one of them) and most of mine make lots of sense. Safety and anti-theft devices have a common-sense relationship with the amount of risk they present to the insurance company (incidentally I use USAA and as a member-owned insurance company I feel I get the best service at the lowest cost under a fairly administered rate system). The problem as I see it is the lack of a common sense relationship between credit score and risk exposure. Even though the data seems solid, the insurance companies themselves do not know why the relationship exists. Either that or they know and they do not want to say because it would seem cruel to make that judgment.

Allow me to weigh in and summarize the correlation, then I will expound on why I believe it is immoral to take advantage of this correlation when pricing policies.

I believe there is a relationship between credit score and poverty. Again, I work in the mortgage industry and I look at people's financial circumstances all the time and the people with the worst credit—in my experience—are the poorest people I deal with. Their regular income is lower than the rest. They don't necessarily have more debt than those with better credit, they simply have a tighter debt-to-income ratio and since housing prices are related to rental prices (thanks in part to the system we use to determine property value for single-family-residences which bleeds into determining fair-market rent for apartments). So generally speaking it is usually only slightly more expensive to buy than rent. The difference more than compensated by the tax benefits of buying, but those with poor credit tend to rent longer than those with good credit because they perceive that buying a home is a hurdle they cannot leap in their present circumstances.

So while those with higher income and good credit buy homes sooner/younger those with lower income and poorer credit tend to wait longer (and I mean several years longer) and their situation tends to worsen (unless they develop a plan and discipline themselves to keep to the plan as long as it takes to fix the situation) thanks to the tendency of landlords to raise rent periodically to keep up with inflation (by the way, landlords often lose money in the first few years of a development only to more than compensate for it within a few years time as their mortgages remain the same but the amount of rent they can charge continues to increase).

By the way, I am not pulling this information out of my butt; I know this because I work in the finance industry and these are some of the first things I learned so I could coach people on the benefits of home ownership, but I digress.

Ok, so if there is a correlation between income and credit score, what the insurance companies are indirectly doing is pricing policies based on income, giving discounts to people who make the most money and subsidizing those discounts by selling policies in the sub-prime market at higher prices. Now if you do not believe this look at the financial relationships between various national insurance brands and how each brand markets itself. There are brands that market themselves right next to Lexus and BMW commercials and others that market themselves on late night television next to beer commercials and "chat-lines." What people may not realize is that these insurance brands may be owned by the same parent company and the profits from one division may cover the losses in the others depending on the actual exposure any given year.

So their claim that 60-70% will see a rate-hike is false. They are simply going to be asked to pay the rate they would've paid without the credit-score discount (and like I said, 30% of those were either getting no discount at all or an insignificant one at that).

So the question I want to ask you is if you believe it is moral to, as a society, require insurance by law, and then punish the poorest citizens by charging them the highest rates for the same coverage?

Have you ever known someone who chose to pay for minor damage to their car themselves instead of reporting a claim? Perhaps the reason the top 40^th percentile presents the insurance companies with reduced exposure is because those people can afford to pay for small repairs and even minor body damage because they are more concerned with the long-term effect that reporting a claim could have on their policy. I've known these people to even pay for the damage to the other person's car in order to avoid the rate-hike. Obviously for the poorest people, this is not an option. Could this be the secret correlation to risk exposure? If so the insurance companies are wrong that any correlation between score and risk of exposure to an accident exists at all, the only correlation is between score and risk of reporting a claim. This is bad behavior to reward, however to the insurance company which is a business, the only thing they really care about is the bottom line.

Finally, I want to remind you what happens when poor people cannot afford insurance. When I got my first car I was still on active duty in the military and the cheapest policy I found at the time was Progressive. I knew I was young and it was my first car so I didn't think that much about paying 1250/6 mo for a policy since I was a new driver and they didn't know how bad or good I would be. Later when I got out of active duty and looked for my first job I was unemployed for a couple months and fell behind on bills. My policy renewal jumped to 1470/6 mo and I missed a payment. I didn't know it, but Progressive drops you as soon as your payment is 1 day past due. I was about to send payment, but this made me upset and I decided not to pay it right away since I had been driving w/o insurance for a few days anyway.

I decided to focus on paying my other bills and forget about having insurance for a couple months. I knew it wasn't a good idea, but I also thought it was crazy that I should have to pay 4x as much as my brother did to insure 2 cars and 2 drivers for me and my one car (by the way, my brother at that time was a terrible driver and had burned out his clutch 2x in his brand new car within 6 years, he made terribly unsafe lane changes and I was shocked he had never been in an accident). So when I got my policy back I decided to shop around and I found USAA and immediately saved 800/6 mo. I have never been without insurance since.

If you punish poor people or people with bad credit you are increasing the likelihood that these people will drop their insurance altogether because it is too much of a financial burden on them. If this happens what will happen is that we will STILL "subsidize" them (as the ad put it) through uninsured motorists' claims. If I had hit someone while I was uninsured, their insurance company would have had to cover all their loss anyway. Sure the insurance company could try to sue me, but given that I am poor and have no assets, I would just declare bankruptcy and they would still be at a loss.

It is in everyone's interest that everyone has access to affordable insurance because the bottom line is none of the predictive factors can absolutely predict who will have an accident and which losses will be most significant.

I appreciate your comments on this one. I apologize that it was so long.

Peace,

Brian

FYI: keep an eye out for Damien Rice's new CD next month!