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The Dallas Morning News recently ran a piece that contained comments you
made about the present legislature. I would like to comment on those you made
about insurance reform.
First, the legislature seems to misunderstand the principles of
underwriting. Underwriting principles are based on averaging risks by building a
client base that is a cross section of the general population. By doing that,
the risk associated with high-risk clients is balanced by the risk associated
with low-risk clients. This principle is amply demonstrated by group health
insurance plans.
This principle implies that the risks associated with individuals or even
sub-groups of individuals need not be taken into consideration. It is obvious
that the use of credit scoring is a violation of this basic underwriting
principle.
The alternative to this way of underwriting is to underwrite each and
every prospective client. Certainly, that can be done, but its enormously
expensive, and because of that probably unworkable.
Consider this example. Our home is insured by a mutual company which
issues annual reports to its members. Recently we received the latest annual
report, a flier consisting of four pages. The first page consists of a statement
from the president, and the last page consists of an abbreviated balance sheet.
The president in his statement wrote "the association dipped into its reserves
for a second year in a row to pay the claims of its members." But the balance
sheet containing figures for the years 2001 and 2002 showed that this claim is
untrue. In both years, premiums more than covered both claims and expenses
associated with paying claims. What was not covered completely were underwriting
expenses which amounted to almost 30 percent of the companys income. Of course,
there are two ways of covering the shortfall: the company can raise premiums or
reduce expenses. Which do you suppose the company chose to
do?
Now to credit scoring. Having spent twenty years in college classrooms teaching logic, I have for some time now sought a copy of even one study that claims to show a significant correlation between losses and credit scores. But you know what?, none can be found. They are all secret! which leads me to believe that the claims are false; otherwise, the companies would be anxious to publish them. (Dewhurst 7/10/2005)