Finding Riches in a Mine of Credit Data
Allstate has boosted its profits and share price by looking beyond driving records.
By Matthew Maier

(Business 2.0) – Jim Rhoades, a securities broker from Erie, Colo., heard about a great rate on insurance last spring. He thought he had a decent deal with State Farm for coverage on his two cars and his home, but a buddy tipped him off to lower premiums at Allstate. Still, the 45-year-old father of two, who had a good driving record, was dubious. "I didn't think they could do anything for me," Rhoades says.

By the time he left the office of a local Allstate agent, however, Rhoades had slashed his annual auto premiums by $400 and his homeowner's premium by the same amount. That's because, in addition to considering Rhoades's ding-free record, Allstate took into account seemingly unrelated information from his credit report, such as whether he pays bills on time (he does) and whether there'd ever been a claim on his home (there hadn't). He not only pays less now but also has higher coverage amounts on both policies. "I feel like a smarter consumer while paying a fraction of the price," he says.

Allstate didn't invent the use of credit data to set premiums, but analysts say the company has perfected the science to a higher degree than any other insurer, making it a weapon for stealing business from competitors. Since 1999, when Allstate began instituting credit-derived premiums, its revenue has grown 26 percent to $33.9 billion, and its stock is up a whopping 187 percent over the same period. (Overall, insurance stocks are up just 31 percent.) In the mid-1990s, a slew of upstart insurers like Geico and Nationwide began stealing business from established players, and since 2002, industry leader State Farm's market share has dropped from 19 percent to 18.2. Over the same period, however, Allstate's share held steady at 11.3 percent, while its annual profit rose 180 percent to $3.1 billion. "Thanks, in part, to its risk management strategy," says Cliff Gallant, an analyst with equity research firm Keefe Bruyette & Woods, "Allstate is enjoying a period of unprecedented profitability."

Premium Predictions

In essence, Allstate is making more money because it's the best at seeing the future. After all, a premium is really a bet: Low rates are necessary to keep competitive, but you don't want to lose money on accident-prone drivers who will make big claims down the road. In the past Allstate, like other insurers, took a simple approach to predicting future claims, assigning customers to one of just three pricing categories based on a limited number of variables, such as age, location, and driving record. But it turns out that adding credit data to the mix yields a far more accurate picture. "Your credit report is not simply a listing of bills," says Michael Gaughan, VP of the insurance unit at credit reporting firm TransUnion, which provides Allstate and other insurers with credit data. "It's a view into how you manage your personal finances, which turns out to be a great predictor of responsible driving."

Ohio-based Progressive Insurance is widely recognized as the first in the industry to apply that insight: It began using credit data to assess drivers' risk back in 1996. But a veritable arms race of statistical modeling has ensued since then, with insurance companies competing to better understand how, say, credit card balances can help predict future claims. Last year Allstate hired the former lead architect of Progressive's credit-scoring program to run its own statistical research, and the company has aggressively assembled a 15-person team of math Ph.D.s, actuarial accountants, and credit industry veterans with decades of combined modeling experience. But experts say Allstate's even bigger edge is that it's blessed with the most valuable resource for building powerful--and profitable--models: decades' worth of data on past customer behavior. "Historically, Allstate has maintained detailed records of insurance claims," says analyst Gallant. "It has successfully mined that data to produce a more nuanced model."

Allstate guards the details of its pricing model the way Coca-Cola protects its secret formula. But VP for product operations Fred Cripe, who heads the company's modeling unit, has winnowed the more than 300 variables typically found on credit reports to roughly 10--such as timeliness of payments and the ratio of account balances to credit limits--that correlate with future claims. Cripe's colleagues began crunching the numbers seven years ago, and last December, Allstate rolled out a fourth version of credit-derived premiums based on their results. With nearly 400 price points, the new rate structure more finely matches premiums to the risk presented by each customer. "Now we can offer coverage to many more people and at far more competitive prices," Cripe says.

Crediting Others

Competitors, of course, are hot on Allstate's statistical trail. Privately held State Farm announced in June that it will begin experimenting with its own credit-based pricing plan, and Progressive is in the process of updating its models. According to research firm Conning, 92 percent of the largest U.S. insurers look at credit scores to determine whether to write new policies. The practice has become so widespread that 40 states now limit the use of credit scores to price insurance on the grounds that doing so discriminates against people with bad credit. "You can claim a statistical connection on a lot of different things, but that doesn't mean you should use it," says Bob Hunter, insurance director at the Consumer Federation of America, which has urged Congress to restrict the use of credit data to set premiums. Hunter and other analysts allege that insurers have found that even hair color and e-mail address domains can be correlated to future claims. "They should ban the whole system," he says.

There's evidence, however, that by perfecting its models to better assess risk, Allstate is actually doing good by doing well. A research study of 2 million policies commissioned by the Texas Department of Insurance found that credit-based pricing reduced premiums for 70 percent of customers. In fact, Allstate is now in the midst of a push to write policies for consumers with poor credit histories--a population of nearly 35 million potential new customers. "These are people with spotty records that we couldn't touch before," says an Allstate agent in New York. "Now we can take them because we have a better idea of the risk they present."

Matthew Maier (mmaier@business2.com) is a writer-reporter at Business 2.0.

AMONG OTHER VARIABLES, WHEN SETTING PREMIUMS ALLSTATE CONSIDERS:

1 Ratio of account balances to credit limits. 2 Timeliness of bill payments. 3 Liens on property.