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.
- Credit scores effectively predict … the total cost of [auto insurance] claims.
- 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].
- ..as a group, African-Americans and Hispanics tend to have lower scores than non-Hispanic whites and Asians.
- …scores effectively predict risk of claims within racial and ethnic groups.
- 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.