Tuesday, September 01, 2015

Consumer Reports on auto insurance, part IV

(Previous posts: part I; part II; part III)

Consumer Reports' biggest complaint is that insurance companies set premiums by including criteria that, according to CR, don't have anything to do with driving. The one that troubles them the most is credit rating:

"We want you to join forces with us to demand that insurers -- and the regulators charged with watching them on ouir behalf -- adopt price-setting practices that are more meaningfully tethered to how you drive, not to who they think you are. ..."

"In the states where insurance companies don't use credit information, the price of car insurance is based mainly on how people actually drive and other factors, not some future risk that a credit score 'predicts'. ..."

"... an unfair side effect of allowing credit scores to be used to set premium prices is that it effectively forces customers to dig deeper into their pockets to pay for accidents that haven't happened and may never happen."


Well, you may or may not agree on whether insurers should be allowed to consider credit scores, but, even if CR's conclusion is correct, their argument still doesn't make sense.

First: the whole idea of insurance is EXACTLY what CR complains about:  to "pay for accidents that haven't happened and may never happen." I mean, that's the ENTIRE POINT of how insurance works -- those of us who don't have accidents wind up paying for those of us who do. 

In fact, we all *hope* that we're paying for accidents that don't happen and may never happen! It's better if we don't suffer injuries, and our car stays in good shape, and our premium stays low. 

Well, maybe CR didn't actually mean that literally. What they were *probably* thinking, but were unable or unwilling to articulate explicitly, is that they think credit scores are not actually indicative of car accident risk -- or, at least, not correlated sufficiently to make the pricing differences fair.

But, I'm sure the insurance industry could demonstrate, immediately, that credit history IS a reliable factor in predicting accident risk. If that weren't true, the first insurance company to realize that could steal all the bad-credit customers away by offering them big discounts!

It's possible, I guess, that CR is right and all the insurance companies are wrong. Since it's an empirical question ... well, CR, show us your evidence! Prove to us, using actual data, that bad-credit customers cause no more accidents than their neighbors with excellent credit. If you can't do that, maybe show us that the bad-credit customers aren't as bad as the insurers think they are. Or, at the very, very least, explain how you figured out, from an armchair thought experiment and without any numbers backing you up, that insurance company actuaries are completely wrong, and have been for a long time, despite having the historical records of thousands, or even millions, of their own customers.


Just using common sense, and even without data, it IS reasonable that a better credit rating should predict a lower accident rate, holding everything else equal. You get better credit by paying your bills on time, and not overextending your finances -- both habits that demonstrate a certain level of reliability and conscientiousness. And driving safely requires ... conscientiousness. It's no surprise at all, to me, that credit scores are predictive, to some extent, of future accident claims.

And CR's own evidence supports that! As I mentioned, the article lauds USAA as being the cheapest, by far, of the large insurers they surveyed. 

But USAA markets to only a subset of the population. As Brian B. wrote in the comments to a previous post:

"[USAA insurance is available only to] military and families. So their demographics are biased by a subset of hyper responsible and conscientious professionals and their offspring."

Consumer Reports did, in fact, note that USAA limits its customers selectively. But they didn't bother demanding that USAA raise its rates, or stop unfairly judging military families by "what they think they are" -- more conscientious than average.


Not only does CR not bother mentioning the possibility that drivers with bad credit scores might actually be riskier drivers, they don't even hint that it ever crossed their minds. They seem to stick to the argument that nothing can possibly "predict" future risk except previous driving record. They even put "predict" in scare quotes, as if the idea is so obviously ludicrous that this kind of "prediction" must be a form of quackery.

Except when it's not. In the passage I quoted at the beginning of this post, they squeeze in a nod to "other factors" that might legitimately affect accident risk. What might those factors be? From the article, it seems they have no objection to charging more to teenagers. Or, to men. They never once mention the fact that female drivers pay less than males -- which, you'd think, would be the biggest, most obvious non-driving factor there is.

CR demands that I be judged "not by who the insurance companies think I am!" Unless, of course, I'm young and male, in which case, suddenly it's OK.

Why is it not a scandal that I pay more just for being a man? I may not be the aggressive testosterone-fueled danger CR might "think I am."  If I'm actually as meek as the average female, the insurer is going to "profit from accidents I may never have!"


I suspect they're approaching the question from a certain moral standard, rather than empirical considerations of the actual risk. It just bugs them that the big, bad insurance companies make you pay more just for having worse credit. On the other hand, men are aggressive, angry, muscle-car loving speeders, and it's morally OK for them to get punished. As well as young people, who are careless risk-takers who text when they drive.

A less charitable interpretation is that CR is just jumping to the conclusion that higher prices are unjustified, even when based on statistical risk, when they affect "oppressed" groups, like the poor -- but OK when they favor "oppressor" groups, like men. (Recall that CR also complained about "good student" discounts because they believe those discounts benefit wealthier families.)

A more charitable interpretation might see CR's thinking as working something like this:

-- It's OK to charge more to a certain group where it's obvious that they generally have a higher risk. Like, teenage drivers, who don't have much experience. Common sense suggests, of course they get into more accidents.

-- Higher rates are like a "punishment," and it's OK, and even good, to punish people who do bad things. People who have at-fault accidents did something bad, so their rates SHOULD go up, to teach them a lesson! As CR says,

"In California, the $1,188 higher average premium our single drivers had to pay because of an accident they caused is a memorable warning to drive more carefully. ... In New York, our singles received less of a slap, only $429, on average."

-- It's OK for men to pay more than women because psychologists have long known that men are more aggressive and prone to take more risks.

-- But it's *not* OK to charge more for someone in a high-risk group when (a) there's no proof that they're actually, individually, a high risk, and (b) the group is a group that CR feels has been unfairly disadvantaged already. Just because someone has bad credit doesn't mean they're a worse driver, even if, statistically, that group has more accidents than others. Because, maybe a certain driver has bad credit because he was conned into buying a house he couldn't afford. First, he was victimized by greedy bankers and unscrupulous developers ... now he's getting conned a second time, by being gouged for his auto policy, even though he's as safe as anyone else!

If CR had actually come out and said this explicitly, and argued for it in a fair and unbiased fashion, maybe I would change my mind and come to see that CR is right. But ... well, that doesn't actually seem to be what CR is arguing. They seem to believe that their plausible examples of bad credit customers with low risk are enough to prove that the overall correlation must be zero!

When a certain model of car requires twice as many repairs as normal, CR recommends not buying it. But when a certain subset of drivers causes twice as many accidents as average, CR not only suggests we ignore the fact -- they even refuse to admit that it's true!


Here's a thought experiment to see how serious CR is about considering only driving history.

Suppose an insurer decided to charge more for drivers who don't wear a helmet when riding a bicycle, based on evidence that legitimately shows that people who refuse to wear bicycle helmets are more likely to refuse to wear seatbelts.

But, they note, it's not a perfect correlation. I, for instance, am an exception. I don't wear a bicycle helmet, but I wouldn't dream of driving without a seatbelt (and I might even be scared to drive a car without airbags). 

Would CR come to my defense, demanding that my insurer stop charging me extra?  Would they insist they judge me by how I drive, not by "who they think I am" based on my history of helmetlessness?

I doubt it. I think they'd be happy that I'm being charged more. I think it's about CR judging which groups "deserve" higher or lower premiums, and then rationalizing from there.

(If you want to argue that bicycling is close enough to driving that this analogy doesn't work, just substitute hockey helmets, or life jackets.)


I'm not completely unsympathetic to CR's position. They could easily make a decent case.  They could say, "look, we know that drivers with bad credit cause more accidents, as a group, than drivers with good credit. But it seems fundamentally unfair, in too many individual cases, to judge people by the characteristics of their group, and make them pay twice as much without really knowing whether they fit the group average."

I mean, if they said that about race, or religion, we'd all agree, right? We'd say, yeah, it DOES seem unfair that a Jewish driver like Chaim pays less (or more) than a Muslim driver like Mohammed, just because his group is statistically less (or more) risky. 

But, what if it's actually the case that, statistically, one group causes more accidents than the other? We tell the insurance companies, look, it's not actually because of religion that the groups are different. It must be just something that correlates to religion, perhaps by circumstance or even coincidence.  So, stop being so lazy.  Instead of deciding premiums based on religion, get off your butts and figure out what's actually causing the differences! 

Maybe the higher risk is because of what neighborhoods the groups tend to live in, that some neighborhoods have narrower streets and restricted sightlines that lead to more accidents. Shouldn't the insurance company figure that out, so that if they find that Chaim (or Mohammed) actually lives in a safer neighborhood, they can set his premium by his actual circumstances, instead of his group characteristics, which they will now realize don't apply here?  That way, fewer drivers will be stuck paying unfairly high or low premiums because of ignorance of their actual risk factors.

If that works for religion, or race, it should also work for credit score. Can't the insurance companies do a bit more work, and drill down a bit more, to figure out who has bad credit out of irresponsibility, and who has bad credit because of circumstances out of their control?

Yes! And, I'd bet, the insurance companies are already doing that! Their profits depend on getting risk right, and they can't afford to ignore anything that's relevant, lest other insurers figure it out first, and undercut their rates.

And CR actually almost admits that this is happening. Remember, the article tells us that the insurers aren't actually using the customer's standard credit score -- they're tweaking parts of it to create their own internal metric. CR tells us that to complain about it -- it's arbitrary, and secret! -- but it might actually be the way the insurers make premiums more accurate, and therefore fair.  It might be the way insurers make it less likely that a customer will be forced to pay higher premiums for "accidents that may never happen."


But I don't think CR really cares that premiums are mathematically fair. Their notion of fairness seems to be tied to their arbitrary, armchair judgments about who should be paying what. 

I suspect that even if the insurance companies proved that their premiums were absolutely, perfectly correlated with individual driving talent, CR would still object. They don't have a good enough understanding of risk -- or a willingness to figure it out.

A driver's expected accident rate isn't something that's visible and obvious. It's hard for anyone but an actuary to really see that Bob is likely to have an accident every 10 years, while Joe is likely to have an accident every 20. To an outsider, it looks arbitrary, like Bob is getting ripped off, having to pay twice as much as Joe for no reason. 

The thing is: some drivers really ARE double the risk. But, because accidents are so rare, their driving histories look identical, and there doesn't seem to be any reason to choose between them. But, often, there is.

If you do the math, you'll see that a pitcher who retires batters at a 71% rate is at more than double the "risk" of pitching a perfect game than a pitcher with only a 69% rate. But, in their normal, everyday baseball card statistics, they don't look that much different at all -- just a two percentage point difference in opposition OBP.

I think a big part of the problem is just that luck, risk, and human behavior follow rules that CR isn't willing to accept -- or even try to understand.

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At Tuesday, September 01, 2015 9:20:00 AM, Blogger Ryan said...

My issue (in this particular case) is that the poor credit score does not necessarily reflect the same thing in all people with a poor credit score. You could have one irresponsible person who is financially strapped (and thus more likely to make a claim against insurance), and another who has no credit score because they carry no debt of any kind. That second person could be very financially successful, and very unlikely to make a claim, and yet they get lumped in with the other low credit score person.

So the main issue is that using a credit score as a proxy for financial success (and thus lower likelihood of making a claim) is flawed and lazy.

At Tuesday, September 01, 2015 12:51:00 PM, Anonymous Matt said...

The fact that there are exceptions doesn't mean a rule isn't useful. Prince Fielder being successful doesn't invalidate the idea that people who are 5'11", 300 lb usually won't make good baseball player.

Further, your example doesn't make sense. "No credit score" and "poor credit score" are not the same thing. That's like saying driving history shouldn't be used because some people don't have one. It's likely that insurance companies have already thought of this.

In fact, that's Phil's entire point. Whatever you or he or I or Consumer Reports thinks of, it's likely that the people who make their money thinking of these things have probably thought of them.

At Tuesday, September 01, 2015 2:30:00 PM, Anonymous Anonymous said...

I think I said this before:

1) Insurance companies wouldn't be doing their jobs well if they didn't try and find every single useful correlation between claim risk and demographics. There is nothing even remotely unethical about this.

2) It is also correct for the government to step in and say, "We don't want you to get too granular with your actuarial analysis for two reasons. One is a little shaky and the other one is 100% correct. One (the shaky one) is that we think it is "unfair" or at least most people think it is unfair, even though it is technically correct, that you use things that are not directly related to driving in order to quantify risk. Two, and this is the reasonable one, we want to make sure that almost everyone is able to afford car insurance so we don't want you to price people out of the market for things that are not directly related to driving.

A good example of this last thing is, let's say that as a group, short people are terrible drivers and their premium should be so high that virtually none of them can afford insurance and thus they can't drive. But, let's also assume that the variance in true risk is high such that half of all short people are such adept drivers that they really have the same risk as an average non-short person. The other half obviously are atrocious drivers and shouldn't even be driving even if they could afford the premiums.

The government can say, look, we know that short people in general are bad drivers and you should offer them very high premiums only. But half of them are really average drivers and we don't think it's fair for you to price them out too. We also understand that you can't distinguish between the terrible and decent short drivers. So we are going to not allow you to charge short people more than anyone else. We also understand that in order to account for the extra risk, you are going to have to charge everyone a little more.

Nothing wrong with that. In fact, it is necessary especially as companies get better and better at assessing risk. As I said in an earlier post, that is exactly what the ACA does among other things of course. It spreads out the extra risk of older people and people with pre-existing conditions so that everyone can afford health insurance, even though in doing so, everyone else pays a slightly higher premium.

Why shouldn't car insurance companies have to do the same? I think that is essentially what CR is saying, although their arguments are worded very poorly (and I am not defending them).


At Thursday, September 03, 2015 4:57:00 AM, Anonymous Anonymous said...

@MGL: #1 and #2 seem contradictory to me. If there's "nothing even remotely unethical" about insurance companies correlating risk and demographics, then why does anyone need to step in and control how they do so?


"We also understand that in order to account for the extra risk, you are going to have to charge everyone a little more. Nothing wrong with that."

I think there's something wrong with that. An insurance policy is a transfer of risk- if you're riskier, you pay more for someone to take on that risk for you. It doesn't matter if it's not someone's fault that they're riskier because of factors outside of their control (shortness in this example)- they're still riskier. All that your theoretical government rules do is raise the price for a different set of people (everyone non-short in this case) for factors outside of their control- someone else's shortness. Why is it OK to charge *tall people* more for a factor outside of their control, but not OK to charge *short people* more for a factor outside of their control?? The only answer I can think of is that whoever chooses demographic chooses them based on who they feel "deserves" it, not based on data or actual fairness. Just the warm fuzzies they get as they pat themselves on the back for being good samaritans (those poor short people get treated so unfairly, I'm so glad we helped them!)

As an under-25yo male with high premiums, I say it's NOT ok to force other people to subsidize my risk. *I* am the risky driver, *I* should pay more, because it's *my* risk the company is taking on. The idea that someone else should pay more for their insurance just because I happen to be young is absurd to me.


"The government can say, look, we know that short people in general are bad drivers and you should offer them very high premiums only. But half of them are really average drivers and we don't think it's fair for you to price them out too. We also understand that you can't distinguish between the terrible and decent short drivers. So we are going to not allow you to charge short people more than anyone else. We also understand that in order to account for the extra risk, you are going to have to charge everyone a little more. ...it is necessary especially as companies get better and better at assessing risk.

This sort of intervention would become *less* necessary as companies got better as assessing risk. As soon as companies got good enough to distinguish good short drivers vs. bad ones, you don't need these extra rules, since they will get charged the "correct" prices. If super-terrible short drivers get "priced out of driving", that's a good thing! We need to incentivize safe driving, not subsidize bad driving at the expense of good drivers (thus disincentivizing good driving too). And how would anybody (even government) have the right to force a company into a contract they're not willing to enter into? E.G. a contract that says they have to take on a bad short driver for $2k/yr when their risk is $4k/yr.

-Jeff H

At Thursday, September 03, 2015 1:41:00 PM, Blogger Phil Birnbaum said...

I was trying to think of how to express what Jeff said, but he said it better than I could.


The only reason to subsidize a short driver is if you have good reason to believe he (or she) is not as bad a driver as the risk assessment suggests. But if it's possible to figure that out, the insurance companies would be the first to know it!

It's true of EVERY group that you have to judge individual risk by the characteristics of the group: even good drivers, and teenagers, and men, and people who have a DUI convictions.

Sure, some short drivers might be overcharged because we don't know they don't fit the profile. But the same is true for EVERYONE. There are some teenagers who (if we could read their minds) are lower risk than their parents. There are some people with DUI convictions to are safer than average. (I know three people who have had DUI convictions, and, as far as I could tell after they got their licenses back, they are now VERY, VERY careful about not doing it again.)

The solution, as Jeff says so well, is to get BETTER at assessing risk. If the insurance company can divide short people into higher-risk and lower-risk, then everyone is more likely to pay by actual driving talent. At that point, we may be sad that some short drivers are really crappy and will cost an expected $4K a year in accident damage, but then it's not a case of unfairness -- it's a case of cosmic injustice, that some people aren't as good at driving as others are.

In that case, you might say, look, it's so awful that Joe Short costs an expected $5,000 a year in accidents, but it's important to society that he be able to drive anyway. If that's the case ... well, we ALREADY have that. Most states have a "high risk pool" and subsidize the highest-risk customers that the insurers won't touch. They still pay very high rates, comparatively, but, I believe, significantly less than their actual expected cost of claims.

So, we're already doing what MGL suggests. We're just not directing it at specific groups by deciding that short people "deserve" it but teenagers don't.

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