Insurance Information Institute (I.I.I.) chief actuary James Lynch offers some perspective on underwriting and auto insurance pricing.
The journalist was working a story on how insurers vary rates in some surprising ways. Over the past few days, industry skeptics have questioned how insurers could have the audacity to charge widows more than married couples, and they have questioned whether drivers with poor credit histories should pay a higher surcharge than a driver with a DUI.
“Does that sound fair?” he asked.
I can’t tell you what the journalist thinks is fair, and of course, my reader friend, I can’t tell what is in your mind.
However, state laws tell insurers what the word fair means, and stripped of legalese, they say a fair rate has to follow the risk as much as possible. People who present great risk must pay more than people who present less risk.
Insurers collect tremendous amounts of data to prove just that.
If an insurer can show that married couples present less risk than others, they deserve a discount. That is fair. It is also fair that men pay more than women and the young pay more than the middle-aged, because the driving records prove it.
Most people think this is OK. They have seen married couples cruising safely in their minivans, and they have been cut off by young, male drivers. Rates follow what they have seen.
By the same standard of fairness, people with poor credit records should pay more than people with excellent credit. Here skeptics balk, yet the data is just as strong, perhaps stronger. Credit information is an excellent predictor of future accidents.
This is harder to understand, I think, because we can’t observe it. I can tell a lot about that fellow who just blew past the stop sign – young or old, male or female – but I can’t tell you, just by looking, whether he is late on his mortgage.
I’ve asked actuaries a lot about credit scores and insurance the past few days. They uniformly tell me its predictive power. People with poor credit incur losses at two or three times the rate of people with excellent credit.
What has surprised me is the certainty and reverence of their answers. One told me, in the jargon: “The models have lift; the standard error is low.” (Translation: Driving record deteriorates steadily, predictably, inexorably as credit score does, without a sliver of doubt.)
Like most actuaries, I’ve known these facts for a while. What surprised me was the respect, bordering on awe, with which these actuaries spoke. They seem to feel they were granted a privileged window, observing something few have – something hard to understand without witnessing it, but once witnessed becomes simple and obvious – as Leeuwenhoek may have felt when he found a drop of water teeming with microbial life.
“The math is there,” I was told. “People just can’t believe what they can’t see.”
Most people benefit from credit scoring. Removing it would raise rates for most people and lower it for a few. And those few will cause more than their share of accidents.
Does that sound fair?