Underwriting

Folks who have followed my posts here are aware that I am a fan of the use of credit scoring in insurance pricing/underwriting. In fact, one of my past jobs focused on the development and implementation of a scoring tool, and in the government- and public-relations exercise related to the implementation.

While credit scoring has been a landmark in the development of predictive analytics in insurance, and it is an incredibly powerful tool…it is just one piece of a larger puzzle, which users ignore at their peril.

While my opinions are based primarily on my insurance background, the same statements hold true for other financial services businesses. For example, consider this column, written by Fair Isaac’s CEO, Dr. Mark Greene, which appeared recently in Forbes:

The reaction in the financial services industry has been to slam the credit window shut. But that’s not a solution. The real question is how lenders can evaluate the individual loans in their portfolios in order to keep the credit crisis from turning into a credit collapse.

The first part of the answer is restoring the prudent application of the three Cs [credit score, capacity to pay, and collateral]. We’ve seen the results of moving away from these “old-fashioned” standards. It’s time to recognize they are necessary modern lending standards as well.

The second part of the answer is high-tech ingenuity, including reliance upon proven credit risk controls like credit scoring. The smart use of credit scoring remains essential, and will in fact benefit lenders who need to wisely balance risk and growth when operating in new or uncharted economic territory.

Looking at this problem, the Consumer Federation of America has proposed, among other things, a test of suitability before giving a consumer a loan. This includes, along with a prospective borrower’s FICO score, looking at their ability to handle added debt payments or interest rate increases. For that good idea to be widely adopted, it will also have to be automated. Such a tool is well within the ability of the industry to deliver.

Of course, I’ve got to believe that Dr. Greene will want shortly to announce such a tool…but that’s what he and his company are in the business of doing.
Just because we have a fancy black box spitting out numbers to which we assign meaning (sometimes too much meaning), it doesn’t mean that every other tool and our common sense must be thrown out the window.

Seen in Monday’s Wall Street Journal: (subscriber link)

A small protestant church in Adrian, Mich., has weathered controversies surrounding abolition, the Civil War, desegregation and Vietnam since it was established in 1836. Now, because its denomination supports gay rights, the church has been deemed too risky for property insurance.

Brotherhood Mutual Insurance Co. of Fort Wayne, Ind., turned down the West Adrian United Church of Christ, citing its national governing body’s approval of gay marriage and the ordination of homosexuals.

“Based on national media reports, controversial stances such as those indicated in your application responses have resulted in property damage and the potential for increased litigation among churches that have chosen to publicly endorse these positions,” Marci J. Fretz, a regional underwriter for Brotherhood Mutual — one of the nation’s largest insurers of religious institutions — wrote in a letter to the church last summer.

While I can imagine a slightly increased threat of physical damage (but then again, churches are surprisingly vulnerable to physical damage; remind me to tell you of the church I was in which was struck by lightning…twice)…increased liability risk?

In commercial lines property/casualty insurance business, insurers generally have additional flexibility in accepting or declining risk than they do in personal lines…so it does seem within the insurer’s rights to do this.  However, it seems wrong.