Texas Supreme Court upholds use of credit scoring in setting insurance rates

The Texas Supreme Court has declared that insurance companies in Texas can use credit scoring to determine how much policyholders will pay for coverage, as long as the credit scoring is “race-neutral.”

The court’s decision — issued May 27, 2011 — was hailed by the American Insurance Association, a trade group for insurance companies, but was criticized by the Center for Economic Justice, a pro-consumer group that opposes the use of credit scoring by insurers.

Birny Birnbaum, executive director of the Center for Economic Justice, says the Texas Supreme Court sided with business interests rather than consumer interests in this ruling.

The Texas Supreme Court says the use of credit scoring by insurers is legal, as long as the scoring is “race-neutral.”

“The court found that insurance credit scoring was OK for insurers to use,” Birnbaum says, “even though the use of such scores leads to disproportionately higher insurance premiums for minority consumers — through no fault of the minority consumers, because insurance credit scores reflect and perpetuate historical racial inequities in the availability and price of consumer credit.”

David Snyder, vice president and associate general counsel of the American Insurance Association, says the Texas Supreme Court made it clear that state law requires credit-scoring factors not based on race to be used when setting insurance rates.

“Texas comprehensively regulates insurance rates both to assure persons with similar risks are treated similarly and to prohibit intentional discrimination based on an individual’s race,” Snyder says. “Moreover, the Legislature has set clear standards, strong enforcement mechanisms and significant penalties for violating these standards.”

Snyder says 46 states permit credit scoring to be used by insurers under regulations similar to those imposed by Texas. Insurers maintain that policyholders with poor credit histories tend to file more claims than policyholders with stronger credit histories.

“Credit-based insurance scoring continues to play a major role in creating a positive and competitive personal (insurance) market,” Snyder says. “Its use allows insurance companies to give more favorable rates to consumers who are less likely to have costly losses.”

The Texas Supreme Court’s ruling came in a case referred by a federal appeals court. The lawsuit was filed against Farmers Group Inc. by Patrick Ojo, an African-American attorney in Houston. When the suit was filed, Ojo had a homeowner’s policy with Farmers.

In 2004, Farmers raised Ojo’s home insurance premium by 9 percent even though he hadn’t filed any homeowner’s insurance claims, according to court documents. Ojo alleged that Farmers increased the premium as a result of unfavorable credit information that the insurer got through its credit-scoring system. Ojo claimed Farmers’ system employs several “undisclosed factors” that result in “disparate impacts” for minorities.

Farmers denied Ojo’s allegations.

The Texas Supreme Court dismissed Ojo’s argument, concluding that Texas insurance law “is void of any language creating a cause of action for a racially disparate impact.” The court said it’s up to the Texas Legislature to allow or prohibit the use of credit scoring in setting insurance premiums that may create “disparate impacts.”

Birnbaum, the Center for Economic Justice director, says the court’s opinion in the Ojo case “has rendered meaningless the statutory prohibition against racial discrimination in insurance by declaring that an insurance company can use rating factors that actually discriminate on the basis of race — as long as the rating factor is a proxy for race and not race itself.”

–John Egan