Bad Credit, Bad Driver

by on July 28, 2007 at 2:12 pm in Economics | Permalink

Some states ban the use of credit scores to price auto insurance in part because African-Americans and Hispanics tend to have lower (worse) credit scores and thus pay higher auto insurance rates.  The brute facts, however, are that credit scores are good predictors of auto claims. Luke Froeb at Management R&D summarizes a recent FTC study on the issue.

  1. Credit scores effectively predict … the total cost of [auto insurance] claims.
  2. Credit scores permit insurers to evaluate risk with greater accuracy, which may make them more willing to offer insurance to higher-risk consumers … . [note: this is why you can call up GEICO, let them look at your credit report, and get an auto insurance quote over the phone].
  3. ..as a group, African-Americans and Hispanics tend to have lower scores than non-Hispanic whites and Asians.
  4. …scores effectively predict risk of claims within racial and ethnic groups.
  5. The Commission could not develop an alternative scoring model that would continue to predict risk effectively, yet decrease the differences in scores among racial and ethnic groups.

Thus banning the use of credit scores would at best force good drivers (of all races) to subsidize bad drivers.  At worst, if insurance companies cannot price according to risk an adverse selection problem could be created in which good drivers purchase less insurance (to avoid having to pay the subsidy to bad drivers) thus pushing rates even higher and perhaps unraveling the market.

michael vassar July 28, 2007 at 2:26 pm

Not to mention that enabling bad drivers to drive more cheaply increases the number of accidents. Since in most accidents both parties are somewhat at fault, this increase in the number of accidents should be expected to be more than linear with any increase in the number of bad drivers. In general, we don’t need society to be arranged so that everyone can drive, but rather so that everyone can get around without too much inconvenience in some manner. The more of a burden we collectively impose upon someone by kicking them off the road the less willing we are to kick them off the road and the more likely they are to impose an increasingly severe safety burden on everyone.

Dennis Mangan July 28, 2007 at 3:00 pm

If the libertarians would only get past the idea that maximizing for them personally is the be all and end all of society we would have a lot less class resentment.

If the liberals would only keep their hands off my wallet (as well as my insurance and annuities), we’d have a lot less theft.

Nick Tarleton July 28, 2007 at 3:30 pm

If the libertarians would only get past the idea that maximizing for them personally is the be all and end all of society we would have a lot less class resentment.

I’m more liberal than libertarian, but I think this is too harsh. Most libertarians are such for reasons other than selfishness.

How do those who say the use of credit scores is racist explain the lower credit ratings of African-Americans and Hispanics? Do they claim bias in the credit bureaus, or do they look for reasons why African-Americans and Hispanics might genuinely have worse credit?

Anonymous July 28, 2007 at 4:32 pm

Dave M,

It is your ability to think and argue rationally that is repugnant and further leads to morally repugnant outcomes.

The first thing that should be clear is in the absence of competition an individual insurance company will only enhance profitability to the extent that the credit scores give it additional information. Thus if credit scores did not enhance the ability of a firm to predict accident rate then they would not use them as they would actually hurt profitability.

The second thing is that insurance is a competitive industry. Once all firms can use this one piece of information, their ability to extract “free” profits from it is removed. The “profit” then moves onto those who have better credit scores. That is, those who this study shows are statistically better drivers

Thus by not allowing the use of credit score you are arguing you would like cheaper insurance policies for bad drivers. By doing this you encourage more bad drivers to be on the road. You also discourage them from changing their behavior in ways which would improve their driving ability. Thus you are encouraging more of the outcomes of bad driving. That is more accidents. Including more fatal accidents involving innocent pedestrians.

More innocents dead in the name of stopping evil “for-profit† corporations. Congratulations. Another victory for the church of modern liberalism.

Charlie July 28, 2007 at 5:06 pm

What if minorities are on average younger than whites? Is it then wrong to use age as a
factor determining insurance premiums? Some insurance companies give a discount to young
drivers who are still in school and have good grades. What if on average that favors
whites? Is that racial discrimination?

For those that don’t know how the statistics works, it isn’t that insurance companies want
to throw out all the other data on age, gender, and driving history, they just want to add
this other measure. We all know that some people have 3 wrecks at 30 because they are bad
drivers and others have 3 wrecks because they were unlucky. Is it possible credit score
could shed some light on this? It doesn’t seem that big of a leap that if a person is
responsible with his money and credit that he/she is also responsible with a vehicle.

Daniel Klein July 28, 2007 at 5:18 pm

Nice post.

If one is looking for a general defense of credit reporting, let me suggest my article in The Independent Review:

http://www.independent.org/pdf/tir/tir_05_3_klein.pdf

Credit reporting is really one of the great social accountability mechanisms, bringing tremendous benefits to all.

Flynn July 28, 2007 at 6:25 pm

Actually, switching to a provider that doesn’t use just credit as a pricing mechanism can lead to dramatically lower rates. I cut my premiums in half when I switched FROM Geico to a competitor who paid attention to my driving history (never had a moving violation or been in an accident) instead of my credit (abyssmal)

Russ Nelson July 28, 2007 at 9:55 pm

Flynn has pointed to the key of the matter. In a free merket, people will have a large variety of life situations. Some companies will provide a good situation for some, and worse situation for others. People will be rewerded for choosing wisely, or not for not.

TGGP July 28, 2007 at 10:08 pm

robertdfeinman, how can it be the case that “we’re in this together” if I never decided to join up with you and become “we”? If I actually was given the choice to join or not, I might actually do so and then we really would be in it together. However, I am not given any such choice, but simply forced into it and told to do “my part”.

Half Sigma July 28, 2007 at 11:15 pm

The problem I have with credit reports is that good people can, for whatever reason, wind up with bad credit reports. This is probably not a concern to the industry. If 1% of people who are actually good credit risks have bad credit scores, the credit reports are still very useful, but very unfair to that unfortunate 1%.

It’s bad enough that people with bad scores can’t get credit. But when they can’t get a job and can’t get car insurance, then they are screwed.

fustercluck July 29, 2007 at 12:01 am

Thus banning the use of credit scores would at best force good drivers (of all races) to subsidize bad drivers.

Good drivers (of all races) subsidize bad drivers no matter what the scenario.

T.W July 29, 2007 at 1:40 am

In an era of data fraud and identity theft I think credit ratings are next to useless for anything since the accuracy of the information can be easily screwed around with.

Daniel Klein July 29, 2007 at 3:39 am

Above, Mark Seecof comments critically on my paper on credit reporting. The main issue here is whether credit reporting agencies should be liable for “errors” in credit reports. Seecof seems to favor restrictions on free speech.

He might be right that I understated the ease with which one could view another’s credit report ca 2000 when I wrote the paper. And I did overuse “exorbitant” in the expression “exorbitant damages.” But those are minor.

On the main points, I don’t think Seecof’s reasoning works at all.

First, I don’t see why he says I say credit reporting agencies would prefer the error of excluding accurate information to that of including inaccurate information. I say that there is a trade-off, and that nobody gains from either kind of error. I also point out that the later type are self-correcting.

But more importantly, his logic of “externality” is no good.

From my paper:

“By focusing exclusively on one type of error, critics engage in asymmetric thinking. If bureaus were made to pay exorbitant damages to consumers harmed by the
inclusion of inaccurate information, should bureaus not also be made to pay damages to businesses harmed by the exclusion of accurate information? Imposing symmetrical
responsibility would put the credit bureaus in a no-win situation and might strangle the goose that lays the golden eggs.

“There is another asymmetry in the complaints against credit bureaus: given that credit bureaus make possible much of the opportunity that consumers enjoy, why should consumers be able to sue credit bureaus when reports have errors, but not have to pay rewards to credit bureaus when reports do not have errors? Critics
are asserting, in essence, that consumers are entitled to have their credit report maintained without serious inaccuracies, but, symmetrically, one could assert that
credit bureaus are entitled to rewards from consumers when reports are accurate. It is wiser to drop the entitlement mentality and think in terms of contractual obligations.”

There are interesting questions of the meaning of “error.”

If a reporter says, “Smith said Jones stole the car,” and Jones did not steal the car, and Smith did in fact say he did, the reporter is not erring. If TransUnion says Visa says Jones did not pay his bill, but Jones did and Visa said he didn’t, is it an error? Arguably, no. If you read a credit report as saying “the creditors says the following”, then most of the “errors” are not credit-reporting-agency errors at all.

As I discuss on p. 327, inaccuracies and misunderstandings arise from many sources other than the credit reporting agency, but they show up in the credit report. Shoot the messenger, and we will have less and worse delivery.

The government and courts do not have any knowledge about where inaccuracies actually originate. How about all the troubles that come from USPS failing to forward mail appropriately? Want to make them liable? If not, why the double standard?

Free speech has given rise to the great social accountability mechanism of credit reporting. Best to keep it as free as we can.

And, yes, I do oppose laws against libel and slander. The best rules are property and contract. Reputation should not be treated as a form of property (discussed pp. 341-342).

Again, the link to my paper is:

http://www.independent.org/pdf/tir/tir_05_3_klein.pdf

TGGP July 29, 2007 at 9:55 am

Property rights in reputation are silly. Of course, I also don’t think much of “intellectual property”, which makes me an outlier.

fustercluck July 29, 2007 at 3:11 pm

I love any credit rating system in which credit inquiries negatively impact the debtor. Sounds perfectly reasonable.

Half Sigma July 29, 2007 at 7:57 pm

“Consumers are not privy to all the underwriting criteria used by insurers and consumers in return, should not be forced to disclose so much to insurers.”

Indeed. Without asymmetry of information, there wouldn’t be much profit for the insurers.

If insurance companies have all information about the consumer, why doesn’t the consumer have all information about how the insurance is being priced?

robertdfeinman July 29, 2007 at 9:25 pm

Alex you can never win an argument with ad hominem attacks. All you illustrate is the paucity of your thought.

You are free to call whatever it is you believe libertarianism, just like the something over 1500 different Christian denominations in the US. Each thinks they have the true interpretation as well.

I’ll say it again, libertarianism is a form of utopianism. It has never existed as a functioning social system and never will. The privileged class uses the appeals to “liberty” to sign up ideologues while it continues to keep an ever expanding piece of the pie for itself.

By the way thanks for taking the time to read some of my essays. As I said before I started this discussion, debating with libertarians is futile, “true believers” need to believe.

If you are satisfied with the crumbs being tossed your way in the current environment then you must be a happy man. So why is it you libertarians are always so angry?

Alex July 29, 2007 at 11:04 pm

Alex you can never win an argument with ad hominem attacks. All you illustrate is the paucity of your thought.

There are no ad hominem attacks in my response. Your ideas are indeed liberal, your tone is highly arrogant and elitist and you attempt to come off as an intellectual, even though most of what you say is eloquently dispensed hot air…something I explained very clearly in response to everything you posted earlier. Your ideas and arguments are also far removed from reality, which I also explained. Sorry, pulling the ad hominem card won’t work here.

You are free to call whatever it is you believe libertarianism, just like the something over 1500 different Christian denominations in the US. Each thinks they have the true interpretation as well.

I’ll say it again, libertarianism is a form of utopianism. It has never existed as a functioning social system and never will. The privileged class uses the appeals to “liberty” to sign up ideologues while it continues to keep an ever expanding piece of the pie for itself.

No system has ever existed in a perfect form, ever, nor will any ever. This is an impossibility. However, different thoughts, ideas and philiosiphies come together in a democratic system in order to make that work as best as possible. Furthermore, every system has roots in an ultimate “what if” senario, an idea of what things would be like if everyone felt the same way.

That said, libertarianism, again, doesn’t even compare with other system in its utopian “what if” roots…like say for example, socialism or communism, where central control tends to consolidate freedoms in an attempt to engineer some sort of utopia…an idea that has failed time and time again throughout history.

If you are satisfied with the crumbs being tossed your way in the current environment then you must be a happy man. So why is it you libertarians are always so angry?

Angry? Nah. More frustrated at dinosaurs like you, who cling to failed political thought and attempt to impose it on the rest of us under the guise of intellectualism that bleeds of ignorance. It’s especially bad when the ideas that you espouse are destructive enough to take away the opportunities out there for people to succeed. Like I said, its scary how many people like you are in positions of political power or are attempting to get there right now.

Sandy P July 30, 2007 at 1:08 am

But why did my release form for my mammogram state the Imaging Service might obtain my credit score?

This is becoming insidious.

Lee July 30, 2007 at 6:54 am

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robertdfeinman July 30, 2007 at 12:50 pm

This has gone on longer than necessary, but it’s a hot day and typing is cooler than the alternatives, so one more time…

1. Arguing by analogy – I claim that libertarianism is a form of utopianism. The reply is that so is (pick your favorite). The fact that Marxism or Socialism were utopian is not a defense. This is a variation of the two wrongs make a right argument. Ideologues on the left have been just as blind as those on the right. All utopian philosophies replace examination of reality with dreams.

2. Anarchism – I don’t know how this got dragged in, but I recently read a nice book on Bakunin. Not only was he not consistent throughout his life as to what he meant by anarchism, but he engaged in ferocious fights with Marx and Kropotkin (among others) as to what was the true path. Anarchism was incoherent from the start, but became a convenient label to apply to those who favored social change. Later is was replaced by socialist, communist, fascist and, most recently, terrorist. Labels are good for bumper stickers, but don’t do much for understanding the social forces at work.

3. The real libertarianism – just like the fights by Bakunin, ideologues tend to form splinter groups and then argue who has the true understanding. I’m not interested in parsing all the distinctions between the factions. You can believe that the Moon is made of green cheese for all I care. What does matter is when we get an acolyte of Ayn Rand made chairman of the Fed. Or when we get Milton Friedman placed in advisory positions where he makes statements such as this “Anything that government can do, private industry can do for half the cost.” Most people prefer not to have their government run by ideologues, but rather by realists and not only realists, but those who will attempt to promote the “general welfare” and not just the fortunes of their cronies. That type of government is usually called a banana republic. I hope we can do better.

gdough July 30, 2007 at 4:40 pm

Posted by Robert:
Most people prefer not to have their government run by ideologues, but rather by realists and not only realists, but those who will attempt to promote the “general welfare” and not just the fortunes of their cronies. That type of government is usually called a banana republic. I hope we can do better.

This statement is particularly humorous to me as it exposes the absolute fairy-tale land you must imagine yourself to live in. You appear to eschew market capitalism and through periodic statements give the impression you promote socialism and worship at the altar of a utopia controlled by the state.

Take any serious look at economics and real-world examples of thriving economic success vs stagnation or outright decline and you discover a pretty stark comparison between market captialism’s dynamism (despite all its flaws) and the moderate to horrendous trainwrecks of statism (despite all their glorified intentions). I’d like to know just what functional universe the non-idealogue “realists” you prefer come from because it doesn’t appear to be the physical reality we live in.

Smith never said corporations were good and altruistic, he only claimed that all our selfish interests in the marketplace would combine into a sum of information greater than any one individual could hold and that information works for the benefit of all. Despite all the evidence to the contrary, you appear to believe he was wrong. I suppose I’m just blind to how the wealthy “man” and evil corporate interests are oppressing me and feeding me misinformation.

TGGP July 30, 2007 at 10:28 pm

robertdfeinman, people have been predicting that capitalism would collapse for a long time now. Marx said it, and it turned out he was horribly wrong and the standard of living kept rising in capitalist countries without any communist revolution all the way through the transition to a post-industrial economy. Paul Ehrlich was predicting it would all crash in disaster and misery by the 1990s. He was wrong and Julian Simon was right. Do you ever get tired of being wrong?

You want a balance of power between government and corporations? Does that mean that corporations should have nuclear weapons, tanks, jet fighters, battleships and so on? The idea that the government needs MORE power is laughable. The power corporations do have is market power, and if I don’t want to buy something from a corporation, there’s not a damn thing they can do about it. If I decide I want to forego the “benefits” the government offers and not my taxes, I will get thrown in jail. And you think corporations have too much power?

Ideologues on the left have been just as blind as those on the right.
Let’s see, all attempts at implementing communism resulted in horrifying levels of poverty and oppression. Actual existing capitalism has delivered the most prosperity the world has ever seen. The people fleeing from the East side of Berlin to the West disagree with you: ideologues on the left have been far more blind than those on the (capitalist) right.

Even today most of the world lives outside of the capitalist system.
Aren’t they lucky. Maybe you should join them. Have fun in Zimbabwe or North Korea, they don’t allow that nasty capitalist growth there. What paradise.

willis July 31, 2007 at 4:03 pm

From what I get from this if you’re black or hispanic they’re saying you’re a worse driver; which is simply not true. On an avg day during rush hour I dodge 9-12 accidents that would NOT have been my fault. Considering all the expensive cars the high & mighty drive I save the insurance companies hundreds of thousands of dollars a year just by ducking these morons on the road not paying attention. What do I get for my hard work, higher insurance rates becasue I’m the “minority”. I think the real minorities are the folks who drive & pay attention to the road & not all the gadgetry in their cars!

TGGP July 31, 2007 at 10:32 pm

robertdfeinman, Ian Smith’s Rhodesia was not a full democracy, but it was nevertheless the breadbasket of Africa. Mugabe’s Zimbabwe African National Union was a Maoist group and the rival Zimbabwe African People’s Union it later merged with was also Marxist, though Soviet in orientation. Mugabe was repeatedly elected and his program of expropriating white property was a major reason for his popularity. This policy was of course a disaster. Massive inflation is also usually initially popular. It is the uncapitalist policies that have been pursued by Zimbabwe that are causing it to collapse, and popular legitimacy does not make that any better. Hong Kong, Singapore and Dubai have all done quite well by pursuing capitalist policies (look up their positions in the Fraser Index). China never became a democracy, but went from a disaster under Maoism to a dynamo under Deng and his successors. Chile has done better than most of its neighbors even though it went through dictatorship under Pinochet. Batista’s Cuba was a net recipient of immigrants from first world European countries. Now even Haitians won’t flee to Cuba. Capitalism is simply a far better predictor of success than democracy, unless you insist on redefining democracy to mean liberal democracy with a capitalist economy, which still leaves the question of how undemocratic capitalist countries have done so well.

As for the rebuttal by historical analogy technique, I covered that before. Just because Malthus and Ehrlich got it wrong doesn’t mean that those analyzing current conditions won’t make better predictions.
Just because the sun rose in the east and set in the west today and every day before that does not mean it will do so again tomorrow. But I am fairly sure that it will. I have similarly seen the optimist capitalist outpredict the pessimist anti-capitalist, and it’s not even the case that the latter has gotten smarter. At least Marx was right about communist revolutions arising, which was the center of his historical materialist framework. You need to give good reasons for why the capitalists are wrong this time when their opponents were always wrong before, and “maybe it will be different now” doesn’t cut it.

By the way why is that those who believe that government is always the problem are such strong supporters of a government run military/police/legal system. How come government gets this right and nothing else?
I don’t believe the government “gets it right” (though almost by definition it maintains its near-monopoly on violence or it wouldn’t be the government) in those areas, but I don’t see the alternative as I have between relatively capitalist economies and ones that reject capitalism. Randall Holcombe explains this in Government: Unnecessary But Inevitable. If you can show me a real example of a better way, I’ll be the first in line to get in.

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