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  • Mea Culpa (Sorta) on Credit Scoring

    June 7, 2007 12:40 PM

    No sooner did I post my thoughts about the Supreme Court decision on credit scoring than I got an e-mail from an American Insurance Association staffer with an impressive bibliography of sources showing a correlation between credit scores and risk. I actually knew about one of the he cites and, for whatever reason, it slipped my mind when I was posting.


    But I still stand by my basic point: use of credit scoring for setting property and casualty insurance premiums seems awfully indirect and, yes, a bit screwy. In a freer market that allowed a broad range of risk factors, I still suspect that we would see it become less important. I agree that it has predictive validity and, since the cost of obtaining credit scores is so low relative to other things, I wouldn't expect it to go away entirely.


    Right now, however, a lot of the best risk factors are currently near impossible to monitor for a mix of political and technological reasons. In part because its received so little emphasis at the federal level (except during a brief period under the Clinton administration) we don't have nearly enough data about what mitigations work to help real estate better deal with extreme meteorological events. We know a lot more about safety equipment on cars but I think we run into a bit of a verification problem there too. Just a few weeks ago, I noticed that I was getting an undeserved discount on my insurance for a feature that had been in the database when I got first got the policy but wasn't actually in place on my car. How was my insurer to know?


    In time, that will change. For the moment, credit scores are useful and well worth using. I just suspect that they would become less useful relative to other factors in a freer, less political market.


  • SCOTUS On Insurance and Credit Reporting

    June 4, 2007 2:55 PM

    A Supreme Court Decision handed down today, Safeco v. Burr, mostly sided with two insurance companies in a dispute over notifications related to the Fair Credit Reporting Act. The real question at hand was to what extent insurance companies had to notify policy holders when they offer them rates other than the lowest as a result of credit histories. The Court found that GEICO did not violate the law and that if Safeco did, it did not do so recklessly. This should let insurance companies breathe a little easier when they use credit scores to determine rates and, insofar as allowing the use of more information leads to rates that better reflect risk, it's likely a good thing.


    But the use of credit scores for insurance in the first place strikes me as a little screwy. Insofar as someone who skips out on a VISA bill might also skip out on a policy premium, I can see how credit scores might impact insurers' bottom lines. But in setting premiums, this seems like a second-rate risk factor. Yes, common sense indicates that people who are careful in paying their bills may be careful when they hit the road or make a fire at home. But I don't know of any research that proves this. Even a strong correlation wouldn't really be very good proof: Everyone knows that younger people have worse driving records AND a harder time paying their bills on time. Thus, I'd tend to think that the use of credit scores may be more of a mechanism for coping with a system that, in many states, limits the use of a risk factors that may have more predictive validity than credit scores. Because they're so easy to get, I'd suspect that insurance companies will always take them into account. But I'd also be willing to be that an insurance system subject to less political regulation would do a better job


  • Banning "Discrimination" That Might Protect Safety

    June 4, 2007 2:49 PM

    Politicians love to vote against "discrimination." It makes them feel saintly, even if the law they vote for has unintended consequences, saddles businesses with red tape, and interferes with public safety. Soundbites matter more than sound public policy.


    Thus, the House of Representatives recently passed the Genetic Information Nondiscrimination Act of 2007, which will probably sail through the Senate as well.


    There is little evidence that anyone is being subjected to irrational discrimination based on their genes. Genetic discrimination of any kind is extremely rare.


    And on rare occasion, genetic discrimination may be rational, such as when genetic testing reveals that a bus driver is prone to seizures that may cause him to crash the bus he is driving.


    But the House has just voted to ban it in essentially all cases, refusing to include a "direct threat" exception to the bill to preserve public safety in scenarios like the bus driver who is prone to seizures.


    An employer or insurer is allowed to consider family medical history when it is relevant. How is genetic information any different?


    It's just superstitious fear of new technologies (genetic testing) on the part of Congress.


    Only three Congressmen had the good sense to vote against this bill: Jeff Flake (R-Ariz.), Ron Paul (R-Tex.) and Ed Royce (R-Cal.).


    The bill is discussed by me and other lawyers in the National Law Journal


  • Selling Insurance on the Web

    May 23, 2007 1:34 PM

    Today's Wall Street Journal (subscription only) features an article about the increasing use of the Web for the sale of insurance policies. I was particularly surprised to see that a recent IBM study showed that only 15 percent of adults would even consider buying an insurance policy directly through a website rather than working through an agent. Another report, however, shows quickly rising online purchases of auto policies.


    This might signal a shift in insurance markets ahead of regulations. Under current regulations, even a transaction taking place entirely on the Web has to pass through an agent who has passed the agents' exam in the policyholders' state. This makes almost no sense. The agent really doesn't add any value to the transaction.


    It seems to me, in fact, that insurance is a near-perfect product to sell on the Internet. Nobody ever has to touch, test-drive, or try it on; it involves lots of paperwork; and the sale of a policy involves no shipping costs. All sizeable insurance companies use complex underwriting systems that give insurance agents little choice as to how their policies get priced. An insurance agent might be able to do some "shopping" for a consumer but, as the success of online travel aggregators has shown, computers shop around much better than people do. Moreover, largely because of overregulation, the basics of personal line property and casualty insurance products have not changed in roughly 50 years.


    When and if more people start buying insurance on the Internet, the case for efforts to open up a national market will become much stronger. We may be at the start of something big.


  • Wildfires in California: A Growing Residual Market?

    May 22, 2007 2:52 PM

    We may be seeing the emergence of yet another residual market for insurance, this time against wildfire. Even though fires have declined a great deal in the United States--and really don't pose a social problem anymore--the wildfire probelm has gotten worse. Particularly in California, many people, most of them rich, have taken to building homes on wooded hillsides. In the dry environment, these hillsides can become fire traps. As a result, the Associated Press reports, companies are getting tougher about writing policies and even withdrawing from some markets altogether. Unlike hurricane zones--which contain lots of lower-income people who may not have the means or ability to leave in the short term--I'd have to think that just about anyone who builds a home on a California hillside has plenty of money.


    It seems to me that it's fine for the insurance companies to raise rates and/or require more mitigations, particularly if the risk of wildfire is growing. Since building on hillsides also tends to promote errosion--an externality--I'd be very cautious of any effort to make sure that rates remain "reasonable" or to establish any sort of residual market for insurance against wildfires.


  • Property Insurance Becomes a Legislative Casualty

    May 18, 2007 10:08 AM

    The Florida legislature recently passed a bill regulating property insurance rates in response to complaints that premiums in certain hurricane-prone areas were too high. Now a rational person might suggest that property insurance premiums in hurricane-prone areas probably should be high, but I wouldn't expect such clarity of thought from someone like Gov. Charlie Crist.


    For a summary of the mess the Sunshine State has made of its insurance market (and thoughts on how to fix it), read Eli's op-ed in today's Tampa Tribune:


    If Tampa Bay area residents don't like Florida's property insurance environment, they only have to wait. Things will get worse. With Gov. Charlie Crist's leadership, the Legislature has so damaged Florida's insurance markets that it now seems only federal laws opening the state's market to outside competition can help the state's residents in the long term.


    Quite simply, the package of insurance 'reforms' will accelerate the collapse of both state-controlled Citizens Property Insurance Corp. and much of Florida's private insurance market over the next decade.


    Indeed, the withdrawal of private companies has already started. Despite laws that make it virtually impossible for them to leave the state altogether and additional recent 'reform' to forbid the creation of new Florida-only subsidiaries, companies like Allstate, USAA, Nationwide, Travelers and The Hartford have already cut back on writing new policies in Florida.


    The whole thing is here.


  • Charlie Crist: Populist

    May 8, 2007 3:02 PM

    Florida continues its populist jihad against private insurance companies. On top of last year's legislation letting the state-owned Citizens Property Insurance Corp. compete outright for private customers while freezing rates, the latest crop of legislation goes further down the path towards socialized property insurance. Citizens is already Florida's largest insurer and will now grow even larger. The new laws also make it harder for companies operating in Florida to wall off their subsidaries and create "pup" insurance companies.


    Gov. Crist, who calls himself a conservative Republican, seems to love this. "I hear some groans from insurance lobbyists," Crist has said. "'Tough!' This is what's right. We work for the people." His web page even styles Crist "The People's Governor."


    For all this talk, I can't see how this benefits the people--common or otherwise. The real problem, the insurance industry's own dirty secret, is that in the long term, it's near impossible to make money simply writing property insurance policies. For 17 of the 20 years before Katrina struck, insurance companies lost money writing policies along the Gulf Coast. For a few years, they'll reap record profits on underwriting but, provided states like Florida don't continue their jihad, competition will drive these profits down to nothing. Insurance companies stay in business in the long-term by investing premium dollars in good years. Real profits come from these investments, not insurance premiums.

  • The Collapse of Private Insurance: Part XXVII

    April 18, 2007 3:21 PM

    A federal jury verdict yesterday in Lousiana requiring Allstate to pay several million dollars it didn't expect to further underlines the inherent problem with our mixed public/private homeowners' insurance system. Allstate has every reason to contend that everything stems from flooding (covered by government) while homeowners, faced with National Flood Insurance Program coverage that has a $350,000 cap, want to have as much non-flood damage as possible. With a house totally destroyed, it's really just guesswork as to who is right. In this situation, private insurance companies have every reason to cut back on coverage. Louisiana's state government was the state's fourth largest property insurer before Katrina. In the wake of this decision, it may well become the largest.


  • The Tip of the Iceberg

    April 9, 2007 10:46 AM

    I have a piece in today's National Review Online about the new bill that would provide optional federal chartering (OFC) for insurance companies. OFC, of course, would let insurance companies do what banks have long done and subject themselves to federal rather than state regulation. This could have good consequences if it lets insurance companies escape burdensome state regulations and move towards risk-based pricing for insurance policies.


    I still haven't even seen the final legislative langauge myself and, as I say in the piece, I think the devil is in the details. But the Sununu-Johnson bill is only the tip of the iceberg. There are other ways whereby we can move our insurance system towards risk-based pricing. Mutual recognition of state insurance charters would accomplish many of the same goals as OFC without enlarging the federal government's powers. Insurance companies, one assumes, would operate in states that provided the laws that most moved towards risk-based pricing.


    Likewise, financial instruments other than conventional insurance, for the most part, can already be sold and priced much more freely. Today, Lloyd's associations, risk retention groups, catastrophe bonds, and weather futures can replace certain types of insurance in certain cases and don't face the regulatory problems of traditional insurance.


    In the other term, I think America needs a broad spectrum of insurance reform proposals. Some ideas that look good at first may fall down in practice and some not-so-promising ideas may turn out better than expected.


  • Is Bad Regulatory Competition Better than No Regulatory Competition?

    April 6, 2007 9:18 AM

    I had an interesting conversation about regulatory competition in the context of insurance. A lawyer I was speaking with argued that any regulatory competition structure—even a deeply flawed one—would help move towards a more liberal, less regulated insurance market. He told me that even a “bad” Optional Federal Charter for insurance companies would get things going in the right direction. (OFC would let insurance companies subject under federal regulation and sell the same product throughout the country without worrying about complying with every state regulatory regime.)


    Although I'm not altogether sold on this position, it does have some solid academic support. The literature on regulatory competition—in particular Dale Murphy's very good 2004 look at offshore finance—suggests that even initially minimal international regulatory competition tends to result in more liberal regulatory regimes in the long run.


    But what works in an international context may not work within a nation's boundaries. An overreaching central government can slow down or even stop competition between states. And the "worst" regulatory competition could, in theory, subject just about everyone to both federal and state regulation.


    Between the 1930s and the late 1970s, after all, banks had a choice of chartering authorities but faced so many regulatory obstacles and outright price controls that bankers worked only a few hours a day and “competed” by seeing who could hand out the most feature-packed toaster.

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