Your credit score might be costing you hundreds of dollars each year on your auto insurance, but you'll never know. It's a secret. And it looks like it's going to stay that way.
Consumers took a shot to the gut this week when the U.S. Supreme Court unanimously ruled that insurers don't have to tell them when they are paying more for auto insurance because of their credit scores.
Many drivers don't even realize their credit scores are used in the complex mathematics used to calculate insurance rates. Ditto for most homeowners. But it's true in most states; credit scores are used to raise rates for some consumers and lower them for others. There's no way to know who is paying more and who is paying less or how much the credit score penalty is because, as I've said, it's a secret.
But Birney Birnbaum, an industry critic who works for the Texas-based Center for Economic Justice, says low scores can actually double some drivers' rates.
Angry consumers recently sued insurance giants Safeco and Geico disputing this secrecy, and won. A federal appeals court agreed with the trial courts, ruling in both cases that it was unfair to penalize consumers because of their low credit scores without providing notice.
But on Monday, the nation's top court overruled the appeals court. America's video replay judges decided the referees on the field got it wrong, and ruled insurers didn't have to provide such notice after all.
In a not-so-thoughtful analysis, Justice David Souter offered one line of reasoning to rule in favor of insurers: Credit score penalty notices would become so commonplace that they would "go the way of junk mail." Really, he did write that. See for yourself. (Acrobat required)
Perhaps Souter can afford to ignore mail that indicates he is paying a $200 penalty surcharge on car insurance, but I suspect few Americans would carelessly toss such notes in the trash.
Higher rate, but why?
Here's what's going on. In general, when a credit score is used to deny a consumer something -- such as a job, an apartment, or a loan -- the Fair Credit Reporting Act requires the company involved to send a letter called a "notice of adverse action" to the consumer. The law makes sense. Millions of credit reports have errors, owing to sloppy data entry or identity theft. Consumers who are penalized have a right to see the report and check for such costly mistakes.
As the use of credit scores has expanded dramatically, far beyond their initial function of determining credit-worthiness, concerns arose about how the notice of adverse action applies in these other arenas. Often, the notices aren't sent at all, and that's wrong. Any time consumers pay a higher rate than they would if they had an ideal credit score, they deserve to know about it.
Birnbaum and others have long argued that consumers should know exactly how much the penalty is, and what the ideal credit score is, so they can check for credit report errors and aim for the ideal score. That was the argument put forth by plaintiffs in the Safeco and Geico cases.
But Geico offered a more tortured, and ultimately more persuasive, argument. It said that it could calculate insurance premiums based on a "neutral" credit score -- in other words, what consumers would pay if credit scoring was never used at all. Only consumers who paid more than this "neutral credit score" rate suffered an adverse action and should be notified, the firm argued. The judges agreed.
Souter: There's a 'loophole'
Souter admits things still aren't ideal. For example, the ruling means there will be consumers who pay higher insurance rates because of credit report errors and will never receive notice, he concedes. He even admits the plaintiffs' assertions that this is a "loophole." But he said he was more concerned about the threat of adverse action notices flooding America with junk mail.
"We think the cost of closing the loophole is too high," he wrote.
There is an even bigger loophole, however, that Souter fails to mention: the setting of this "neutral rate." What will it be? Certainly it won't be an average credit score. It might even be so low that virtually no consumer receives an adverse action notice.
Justice John Paul Stevens saw it that way and wrote in a separate opinion that he disagreed with the majority's logic on that point: "I find it difficult to believe that Congress could have intended for a company's unrestrained adoption of a "neutral" score to keep many (if not most) consumers from ever hearing that the credit reports are costing them money."
He also poked fun at the rest of the court and its junk mail reasoning: "The court ... (reasons) that frequent adverse action notices would be ignored. To borrow a sentence from the court's opinion: 'Perhaps.' But rather than speculate about the likely effect of hypernotification ... I would defer to the Solicitor General's position, informed by the Federal Trade Commission's expert judgment, that consumers by and large benefit from adverse action notices, however common."
In this case, our nation's highest court of referees missed a foul call. The tortured logic of protecting us from junk mail (why start now?) is comical. Allowing insurance companies to set the bar for when adverse notices are sent is akin to giving the fox the keys to the chicken coup.
The ruling is even more discouraging when you consider the ever-expanding universe of credit scores, which are used to judge us in more realms every day. Clearly this ruling emboldens any industry that plans to use credit reports to penalize us and wants to do so in secrecy.
Red Tape Wrestling Tips
• Not all states allow insurance firms to consider credit scores. The practice is banned in California, for example. Call your state legislator and ask him or her to support a ban on the use of credit scores to set insurance rates in your state. Congress could amend the Fair Credit Reporting Act to require more adverse action notices by insurers, but that's a pipe dream at the moment.
• Your state's insurance regulators can control the use of credit scores and adverse action notices, says Birnbaum. Contact your board and ask it to do more.
• As with all major purchases, shop around. Get quotes from at least three companies before buying insurance, as each firm uses its own algebra to apply credit scores.
• Before buying home or auto insurance, get your CLUE report. CLUE stands for Comprehensive Loss Underwriting Exchange. It's a massive database used to log claims you make, or claims made in association with any property. Never buy a home without first ordering a CLUE report for that address, as home insurance rates can vary house-by-house, and some homes simply can't be insured because of a history of claims. CLUE reports are free from the company that maintains the database, ChoicePoint, and are available at ChoicePoint's consumer Web site.
• Finally, beware notices from insurance companies offering congratulations for a discount you've earned thanks to your credit score. Birnbaum says these are often adverse action notices is disguise, offering a small discount from a higher rate.
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