imposed after the fact by a third party unrelated to the transaction. In credit scoring, penalties can be attached to positive
behaviors, such as seeking out a fixed low interest rate or canceling a credit card in response to bank errors. More people may
decide against defending themselves in small claims court if the
costs of being ruled against will include elevated monthly bills.
Consumer power overall diminishes when inflated third-party
prices are attached to choice.
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■ homogeneity—Homogeneity is a simple concept describing similarity among risks. Since individual policy experience
is highly random, insurance results are relevant only as a group.
Insurance risk was never intended to be identified down to the
individual level. Yet groupings must be proper for the individuals who are placed within them. It makes sense to apply
a territory relativity to adjust for hazards specific to a region,
such as traffic congestion. It doesn’t make sense to surcharge
a subset of drivers or homeowners who choose to hold retail
credit cards, when Javier charged stereo equipment for parties
at his apartment while Rosalinda charged home improvements
to remodel a historic home for her retirement. Even if the retail card grouping behaves similarly as a group, the conditions
for grouping these individuals are behavioral—and there are
marked differences in the behaviors.
A group of loan holders may include real estate investors,
purchasers of yachts, and those indebted to amenities like classical instruments. Yet it could be surmised that those in greatest
need of loans are those who elevate the insurance risk. Insurers
might have an incentive to ignore the underlying reasons when
a system surcharges those with financial struggles. A system
that overtly does that could be received negatively by the public. By pooling groups inappropriately, the reason for charging
higher premiums is masked and there’s no appearance of discriminating on the basis of wealth.
■ Manipulation—Manipulation is the ability of people to alter
their risk classes downward in order to pay a lower premium
without making any changes to reduce their true level of riskiness.
For example, under a pay-as-you-drive auto insurance system,
some may be tempted to reset odometer readings. On the other
hand, an individual’s conscious decision to drive less wouldn’t be
considered manipulation since reduced travel should reduce loss
exposure (if the distance measure of risk is valid). Third-party
credit reports, like odometers, are well protected from manipulation. But if people were to adjust their credit choices to reduce
insurance costs, could this be viewed as manipulation?
Trade secret status on credit scoring models has been granted
in many states. Companies want to protect the inner mechanisms
of models they developed to gain competitive advantage. If trade
secret status were removed, a model’s predictive ability—and its
value—could gradually diminish. Consumers might demand
explanations about the models’ rate effects, and then insurers
would face the costly task of educating the public and responding
The grocery card example 540 720
Much of the mystery behind credit scoring erodes when replaced by familiar concepts. Suppose rating models are based on grocery
reward cards that track purchases of foodstuffs and
ordinary household goods. Insurance companies could
claim that there’s no discrimination because no data
are gathered on ethnicity, nationality, religion, etc . But
how would the public perceive disparities in insurance
costs between the steak-and-potato shoppers
and the rice-and-beans shoppers? Home
gardeners and avid restaurant-goers might
argue against penalties for sparse data. If
school teachers were to buy party umbrellas for class art projects, would they
be rated with the social drinkers? If the
model relationships were disclosed to
those who are insured, would their food
choices alter? Would dietary changes allow insurance rates to be manipulated?
to complaints. Credit card applicants might begin to wonder how
much those free airline points actually cost, and banks might object to diminished markets due to third-party charges.
Efforts to manage finances, like managing risk, should be
viewed favorably by society. The “Click It or Ticket” campaign
encourages people to fasten their seat belts. People can learn
to be better drivers, and they can learn to be better stewards of
risk. Such lessons, however, are rarely learned under secrecy.
Truth in lending—Mobile
Like the towers of the World Trade Center, which were designed
in the 1960s to withstand the impact of the largest fully loaded
passenger plane in operation at that time, the Truth in Lending
Act of 1968 (TILA) was designed to protect consumers in credit
transactions that existed at the time.
It’s no longer possible to physically explore the structural
integrity of the twin towers because they were both taken down
by fully loaded passenger planes. In reviewing TILA for structural integrity, it would appear that insurance credit scoring
isn’t covered. The scoring produces a third-party charge that
wasn’t a known use of credit at the time.
In the absence of a hardship clause, I thought TILA would
have offered a good portion of the financial protection that I
needed after making my way out of New York’s financial district
on foot on Sept. 11 and starting over with difficulty many months
later as a state regulator. TILA was intended to give consumers
the knowledge necessary to make solid financial decisions. Its
original purpose was to protect consumers from being undermined by unforeseen costs when making important financial
