Kucera.Credit

At an NAIC hearing in 2009, Jeff Kucera (AAA member) discussed credit scoring as a rating variable. Although credit scores can be distorted by downturns in the economy, he felt that credit score is a good rating variable.

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BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• how an economic downturn relates to the use of credit scores
• arguments for and against use of credit scores

reference	part (a)	part (b)	part (c)
E (2017.Fall #1)	economic downturn: - response to regulator	see McCarty.Credit	credit scores: - actions limiting use
E (2016.Fall #2)	economic downturn: - regulator concerns	economic downturn: - impact on rate filing	economic downturn: - rate caps & pricing principles
E (2014.Spring #5)	credit scores: - arguments for	see McCarty.Credit	economic downturn: - impact on stakeholders

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In Plain English!

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Definition of Credit Score

This is a pretty easy paper. An insurance score is a numerical score assigned to an insurance risk based on a risk's underlying characteristics. And a credit score is an example of an insurance score that uses attributes found in a credit report. (deleted link)

When I hear the term credit score, here is what pops into my head:

Credit scores are highly predictive of claims costs, but many people think their use is unfair. The use of credit scores as a rating variable is banned in many jurisdictions.

Let's try to understand what this is all about. First, what specifically would insurers like to use credit scores for: (deleted link)

• as an U/W criterion
• as a rating variable
• for assignment to tiers

So, if you have a low credit score, you may be outright rejected or you may be charged a high rate. But it also works the other way: If you have a good credit score, you'll likely get a lower rate. The issue that regulators have is that credit scores may be unfairly discriminatory and that would violate one of the main principles of actuarial pricing.

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Social Concerns

The use of credit scores can have an impact on the aggregate premium a company collects, and/or on the individual premium of a specific customer. (Keep this distinction in mind.) Here is a straightforward exam question from (deleted link).

Question: what are some arguments for and against the use of credit scores

for: credit scores are statistically significant and that removing credit scores won't change aggregate premium.

against: credit scores are unfairly discriminatory (poor families, recent immigrants), and privacy concerns.

Economic Downturns

An interesting question concerns the effect of an economic downturn on credit scores. (See Battletable for relevant exam questions.) Downturns will happen from time to time because of the cyclical nature of the economy. In a downturn, an individual may lose their job and be unable to pay their bills. Obviously this would have a negative impact on their credit score and may cause their auto rates to increase, but would their accident frequency increase? Probably not. In fact, if they didn't have a job and didn't have to drive to work, their accident frequency would likely decrease.is about regulators' concerns over credit scores in an economic downturn.

Question: what concerns might a regulator have regarding credit scores in an economic downturn

• an unwarranted increase in aggregate premiums if the average credit score got worse
• a distributional shift in individual premium that doesn't reflect true cost differences (losing you job doesn't mean you'll have more car accidents)

Of course, the actuary always has a great response to regulators! Alice the actuary would simply tell them:

1. We can apply an off-balance factor to keep the aggregate premium unchanged.
2. Regarding individual premiums, we can stop using credit score (at least temporarily) and redo the classification analysis after the economy has stabilized (this may incur a significant lag time however)

In the next mini BattleQuiz, it looks like I've included duplicate questions, but if you click on the "E" to see the actual exam problem, you'll see the way they asked the question is different.

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Related Syllabus Readings

To round out your study of credit scoring, take a quick look at

BattleCodes

Memorize:

• defn of credit score
• uses of credit score
• arguments for and against using credit scores
• regulators' concern in an economic crisis & actuary's response

Conceptual:

• Can you integrate the info from this reading with the other parts of the syllabus that are related?

Calculational:

• none

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