Tuesday, March 07, 2006

New Jersey wrestles with the Brave New World of insurance

When New Jersey rewrote its insurance laws in 2003 with an eye toward encouraging more competition and lower prices, most people focused on the likelihood that new entrants would seek a competitive edge by drawing different ratings maps or using credit histories in pricing — already common practices in Pennsylvania and most other states.

Little attention was paid to the other aspects of the sophisticated pricing models that have moved into the industry’s mainstream over the last decade. But that changed abruptly last week, when the Star-Ledger of Newark reported that Geico was using education and occupation as part of its New Jersey pricing models.

The head of New Jersey Citizen Action labeled the practice unconscionable, and told the paper: “I would love to know who they are marketing themselves to? Are they writing letters to doctors and lawyers? Everybody should be putting down that they are Rhodes scholars.”

Now, legislators have introduced bills in both the General Assembly and the Senate to ban the practice. “Education and occupation has nothing to do with someone’s driving record,” said Assemblyman Neil Cohen of Union County, who introduced one of the bills, according to an article in today’s Star-Ledger. “There’s no relationship at all except to give someone the opportunity to charge regular folks a higher rate.”

The same criticisms have been leveled at insurers' use of credit information — typically reduced to a credit-score-like "insurance score" or "financial-responsibility score" — in pricing. How can it be a legitimate factor, critics ask, when whether you pay your bills on time has no obvious relationship to driving performance?

Insurers who rely on credit — probably the vast majority now — respond that they use the data along with a host of other factors to try to predict the likelihood that they'll have to pay out claims on somebody they insure. Whatever the underlying reasons, they say, how you handle your finances has proved to be a pretty good predictor of their risk of future losses.

But the jury is still out on the use of credit-based scores in auto insurance. Pennsylvania doesn't allow their use in decisions to cancel or rerate an existing policyholder — so your premium can't go up, say, if your bill-paying performance suffers because you lost your job. But it doesn't bar insurers from using credit in their initial decisions to issue a policy or assign it to a pricing tier.

Interestingly, "occupation" is among the classifications that Pennsylvania bars insurers from using in deciding whether to write a policy, or whether to refuse renewal, according to Randy Rohrbaugh, a deputy insurance commissioner. It's listed in the state's Unfair Insurance Practices Act, along with race, religion, nationality, ethnic group, age, sex, family size, place of residence, and marital status.

But the state does allow occupation — unlike race, religion, nationality or ethnic group — to be used in pricing policies, so long as they have data showing that occupation does, in fact, help them predict risk. That's the same standard New Jersey has adopted in allowing Geico and other insurers to use occupation and education in auto-insurance pricing.

One oft-heard argument against the use of credit data could also be raised against the use of education and occupation: that they could be proxies for discrimination against racial or ethnic groups. Since insurers treat their scoring models as proprietary, it's been very hard for outsiders to judge. But the Geico story has provided an unusual glimpse into one company's use of occupation-based ratings.

According to the Star-Ledger's initial article, a Geico internal manual showed how the company viewed a person's job and education.

Accountants, architects, lawyers, teachers, engineers and dentists were listed as occupations with "superior loss experience," the paper quoted Geico as saying. Among those at the other end of the spectrum were clerks, long haul drivers, route men, and "unskilled and semi-skilled blue- and gray-collar workers."

As for education, the manual said: "Risks who have achieved at least a high school diploma or its equivalent are more favorable than those without a high school education. Bachelors, masters and other advanced degrees are considered most favorable."

Is that discrimination? Absolutely. But it's the kind of discrimination routinely defended as a key aspect of the insurance business: finding ways to slice and dice the population to predict relative risk, and charging enough to cover a range of risks at a profit. The law says insurers "can't unfairly discriminate," Rohrbaugh says.

Rohrbaugh points out that some insurers have built entire business models around occupational classifications — offering to cover "all members of the Grange," for instance, which means covering farmers, or to cover active members of the military.

He says Pennsylvania has disciplined some companies for refusing to cover some people because of their occupations — for instance by turning down professional athletes, students or actors. But if what you do can be shown to be a reliable predictor of how much you'll cost your insurer in claims over the long haul, the state isn't saying no.

"That’s why we always talk about 'shop, shop, shop,'" Rohrbaugh told me. As a consumer, you want to find a company that elevates factors that make you look good, and discounts factors that don't.

Personally, I'm glad to see New Jersey's experience shedding more light on how insurers do their business. Insurance really is all about discrimination. That's why regulators and the public should want to know more of the disturbing details — because when it comes to discrimination, deciding what's unfair and what's unfair is really up to us.


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