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Why Low Credit Scores Predict More Auto Liability

Claims: Two Theories

Patrick Butler*American Risk & Insurance Association

August 7, 2007

*National Organization for Womenpbutler@centspermilenow.org

#774.7804

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Policy dilemma: get “A” w/o getting “B”

A. Mandatory liability insurance– Public demands it

– Insurers oppose it because of “B”

B. Price regulation– To keep mandatory insurance affordable

– Recent example is initiatives to ban or regulate credit score (CS) pricing

– In response auto insurers commissioned a large study completed in 2003

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Claims per 100 car years: +90% to -25% of average

1.90 / 0.75 = 2.5 times

+90%

-25%

Figure 1. Liability Claims vs. Credit Scores(from Miller & Smith 2003)

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Theory 1 “More driver negligence”

• Basis for theory

– Each liability claim requires a negligent act by insured car’s driver

• Logic

– Cars of low CS drivers average more liability claims

– Therefore these drivers are more negligent

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Theory 1 (continued)Explanations

• Miller & Smith 2003 (insurance industry explanation)

“[Credit-based] scores seem to provide an objective means

of measuring personal responsibility and its effect on

insurance losses.”

• Brockett et al. 2005 (1st academic study)– Presented at WRIEC, Salt Lake City

– Published 2007

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Theory 1 (continued)biological explanation

Brockett & Golden 2007 (J. Risk & Insurance)

• Title (underline added):

“Biological and Psychobehavioral Correlates of Credit

Scores and Automobile Insurance Losses: Toward an

Explication of Why Credit Scoring Works”

• Conclude that the research examined by their study

“suggests that the discussed individualized biological and

psychobehavioral correlates provide a connection between

credit scores and automobile insurance losses.“

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Model for Theory 1 is the biological explanation for correlation with driver age

Driver Age

Similar age effects confirmed per worker hour of exposure

Involvement Rate =Accidents per 1,000,000 miles

(from Williams 1999)

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Theory 1 Unaddressed Matters

• Claims & accidents are referenced to driver- and car-years, but individual annual-miles exposures vary widely

• A conflict with risk aversion theory

– Greater financial constraint predicts more risk aversion, i.e., less negligence

• Insurers report that lower CS also predicts more uninsured motorist (UM) claims.

– But a UM claim requires non negligence by the insured car’s driver

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CS Theory 2“More miles per insured car year”

• UM & Liability Claims must correlate (+):– The more miles a group of cars averages, the more

claims per 100 car years the group produces

• more negligence claims, and also

• more non-negligence (UM) claims

• This means that the cars of financially-constrained drivers must be averaging more miles. Why so?

• But first some basics:

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Basics for Theory 2

• Given – Accidents are a cost of car operating

• Given – Premiums are a cost of car owning

• But is the range in annual miles enough to explain the 2.5 times CS variable range in claims per 100 car years?

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Fig. 2. Yes. Household Cars Distributed by Odometer Miles Shows Range

• Subgroups by car age, and by driver sex and age (despite difference in averages) span entire annual-miles range

• So cars within insurance classes span low- to high-miles

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Annual Miles (000)

Cars

4.4% > 32K miles

Mean = 11,801 milesMedian = 9,448 milesN = 32,153 carsN = 32,153 cars

1.0% = 0 miles

WOMEN DRIVERS AVG = 10,143 MILES

MEN DRIVERS AVG = 16,553 MILES

Figure 3 (Recasting of Figure 2)

12 The CS range in claims: 2.5 times = 15,000 mi / 6,000 mi

Figure 4. Why miles must be individually measured

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Avg miles explain why new cars average more liability claims than old cars But distribution shows many new cars are driven fewer miles than old cars

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Logic of Theory 2 illustrated(Hard but sure way to economize)

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Theory 2 fits other predictors

1. Zip code income (-)2. Education & occupation (-)3. No prior insurance (+)4. Installment plan (+)

X. Any marker of tight budgets predicts more liability claims per 100 car years

Therefore, the highest per-car premiums are charged to those who can least afford them

Theory 2 recommends

• Informed by Theory 2, the strong public demand for enforcing mandatory liability insurance could be accompanied by

– A strong demand that automobile insurers provide the audited odometer-mile exposure unit as an option

– At cents-per-odometer-mile class prices this option would constitute a free-market remedy for the upward cost-price spiral that the traditional car-year exposure unit sets off for groups of economizing drivers

– With this option drivers could car pool or take the bus to save on insurance while keeping their own cars insured and available for use

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Table 2. What’s at stake – the challenge for both theories

Range: $1,136 / $258 = 4.4 times

Insurance Company PremiumALLSTATE PROP & CAS INS CO 258

GEICO 318

PROGRESSIVE NORTHEASTERN 326

STATE FARM MUT AUTO INS CO 375

GEICO IND CO 492

METROPOLITAN GRP P&C INS CO 641

AUTOONE INS CO 854

ALLSTATE IND CO 1,136

e. g., Albany, NY: lowest and highest quoted for one car class profile (same driver age, record, sex, and marital status).

Conclusion – Research questionWhich policy response to the dilemma

“free-market vs. affordability vs. mandatory insurance”

• Theory 1, some issues– Identify the negligent driver groups on an

accidents-per-1,000,000-mile basis– Find incentives to reduce negligence per-mile

• Theory 2, some issues (discuss in Q & A)– Federal surveys show average miles per car year

decreases moderately as household income decreases– Some high premiums for adult-driver-class cars may

reflect not only higher miles per car, but also the higher per 1,000,000 mile accident involvement rates of “undisclosed” young and old drivers sharing the cars

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