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Biological and Psychobehavioral Correlates of Risk Taking, Credit Scores, and Automobile Insurance Losses: Toward an Explication of Why Credit Scoring.

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Presentation on theme: "Biological and Psychobehavioral Correlates of Risk Taking, Credit Scores, and Automobile Insurance Losses: Toward an Explication of Why Credit Scoring."— Presentation transcript:

1 Biological and Psychobehavioral Correlates of Risk Taking, Credit Scores, and Automobile Insurance Losses: Toward an Explication of Why Credit Scoring Works Patrick Brockett and Linda Golden Presentation to the Casualty Actuarial Society Predictive Modeling Conference on October 11, 2007, Las Vegas, Nevada

2 Reference for details:  Brockett, Patrick L. and Linda L. Golden “Biological and Psychobehavioral Correlates of Risk Taking, Credit Scores, and Automobile Insurance Losses: Toward an Explication of Why Credit Scoring Works,” Journal of Risk and Insurance, Vol 74(1), March  Available electronically from JSTOR, Blackwell Publishing, accessible from or by ing the authors  75 Copies available at the meeting

3 The most important development in the past two decades in personal lines of insurance may well be the use of an individual’s credit history as a classification and rating variable to predict losses.

4 Empirical Relationship Demonstrated The statistical evidence between insured losses and credit score has been repeatedly demonstrated. Very strong correlation between a bad credit score and increased insurance losses. Research Examples......

5 Excerpted from University of Texas study conducted for Texas legislature, 2003

6

7  Tillman and Hobbs (1949): drivers with bad credit history have repeated crashes at a rate six times higher than those with good credit history.  Washington state study (1968): within the group with a history of no automobile accidents, 64% had good credit and 35% had bad credit-- among group with two or more automobile accidents, 35% had bad credit, -- almost twelve times the percentage (3%) who had good credit  Other correlates: divorce, legal problems, job turnover, lower education

8 “…a man drives as he lives.” Tillman and Hobbs, 1949 Research Results Summarized

9 The purpose of this research is to present a “missing link” explaining why credit scores are associated with insurance losses. The outcome of the debate over the use of credit scoring has implications for the social acceptability of Actuarial Standard #12, and has implications for other variables useful for underwriting.

10 Heuristic Model  Insured Loss = f(X 1,X 2 )  Credit Score = g(Y 1,X 2 ) Where: X 1 denotes a vector of automobile specific characteristics, X 2 denotes a vector of person specific psychological (and possibly biological) characteristics, and Y 1 denotes a vector of credit specific attributes  Proposition: The correlation between Insured Losses and Credit Score is high and positive because of the common vector factor X 2 (which is in turn correlated with both X 1 and Y 1 ).

11 Risk Taking Behavior (Driving) Risk Taking Behavior (Financial) Credit Score Insured Auto Losses Bio- chemical Psycho- behaviora l Profile Simplified Model of Conjunctive Influences between Insured Losses and Credit

12 The Core Idea  Connector between risk taking behavior in automobile insurance losses and credit scores and financial risk taking is the psychological dimension.  Most easily identified psychological characteristic is the personality type known as “sensation seeking” or “novelty seeking.” It is related to responsibility and risk taking.

13 Psychobehavioral Profile of Sensation Seeking/Novelty Seeking Risky Behaviors Risky DrivingHigh Risk Occupations Drinking/ Driving High Risk Sports Drinking/ Drug Use Reduced Personal Responsibility Overestimation of Skills Increased Perceived Benefits Reduced Perceived Risk Reduced Deliberation 1 These terms are often used interchangeably in the literature. The “sensation seeking” term comes from Zuckerman (1979) and “novelty seeking” is attributable to Cloninger (1987).

14 “If serotonin is the brakes, dopamine is the accelerator in the drive to risky behavior.” Zuckerman and Kuhlman, 2000 A Biological Component

15 Biochemical and Psychobehavioral Profile of Sensation Seeking/Novelty Seeking Stress Antisocial Behavior Depression Exploratio n Arousal Amplifies reaction to stimuli Impulsivit y SENSATION SEEKING Low Levels of Cortisol Low Levels of Serotonin High Levels of Testosterone High Levels of Dopamine High Levels of Norepinephrin e Low Levels of MAO-A Corticosterone Low Intellect Low Education Low Occupational Status High SES Employment Marriage Biochemicals Risk Taking Responses Socio-cultural Outcomes Mediating Factors LEGEND Low Levels of MAO-B 1 These terms are often used interchangeably in the literature. The “sensation seeking” terms comes from Zuckerman (1979) and “novelty seeking” is attributable to Cloninger (1987).

16 Influences on sensation seeking and novelty seeking have implications for automobile insurance losses.

17 Comprehensive Overview of Biochemical and Psychobehavioral Influences Related to Paid Automobile Insurances Losses Testosterone Corticosterone Monoamine Oxidase Cortisol Serotonin Norepinephrine Dopamine Risk Appraisal Judgments Risk Perceptions Judgments Sensation Seeking/Novelt y Seeking Impulsive Driving Decisions Inattentive to Details or Environment Irresponsibility Regarding Driving Behavior Other High Risk- Taking Behaviors Distractibility/ Lack of Focus Aggressive/ Antisocial Behavior 3rd Party at Fault Accident At Fault Accident Accident Caused by Act of God Potential Biochemical Influeners Driver Psycho-behavioral Profile Risky Driving Behavior Accident Characteristics Actual Loss to Insured Vehicle Characteristics Insured’s Loss Mitigation Activities Reported Loss to Insurer Insured’s Possible Claim Size Build-Up Insured’s Reporting Decision Prior Policy Limits & Policy Coverage Decisions by Insured Actual Paid Insurance Losses Prior Deductible Choice by Insured Driver Psychological and Economic Profile Influences Post-Accident Decisions and Influences on Loss Amount Loss Incurred by Insurer Biochemical Psycho-behavioral System Feedback Age, Gender, Marital Status, Education, SES, Rural/Urban/Inner City Dweller Driver Characteristics & Demographics

18 Financial decision making is also related to psychobehavioral and biochemical variables.

19 Brown and Harlow (1990) examined blood samples and determined that financial risk taking is related to blood chemistry. Other research has shown sensation seeking/novelty seeking is related to financial decision making……….

20  Reduced risk perception and risk appraisal play an important role in the individual’s propensity for sensation seeking which, in turn, is an integral part of the individual’s financial decision making.  Risk tolerance is evident in both the filing of insurance claims and excessive credit card use (impulse buying which may be linked to MAO and dopamine or financial stress linked to serotonin, cortisol, dopamine, and norepinephrine).  Debt and poor money management create and are the result of financial stress which may be linked to serotonin, cortisol, dopamine, and norepinephrine.  Each of these decisions directly impacts the individual’s credit score which is often used as a variable in predicting losses in automobile insurance coverage.  Miraplex and chemically induced risk taking

21 …and financial decision making determines, in part, a person’s credit score…

22 Comprehensive Overview of Biochemical and Psychobehavioral Influences Related to Credit Score Monoamine Oxidase Cortisol Testosterone Serotonin Norepinephrine Dopamine Corticosterone Risk Appraisal Judgments Risk Perception Judgments Sensation / Seeking Novelty Seeking Divorce Medical Exigency Impulsive Financial/Purchase Decisions Inattentive to Details or Environment Distractable/Unabl e to Focus Irresponsible Regarding Financial or Credit Obligations Total Credit Card Debt to Credit Line Ratio Defaults on Debts or Derogatory Public Records Length of Credit Record Missed Payment History Late Payment History Number of Credit Lines Open Credit Inquiries in Past 30 Days Credit Score Unemployment Potential Biochemical Influencers Psycho-behavioral ProfileRisky Financial/ Credit Behavior Economic Exigencies Credit History Record

23 Notice that: The same risk taking correlates show up across realms from driving to financial decision-making. Why?

24 Possible Theoretical Explanations Risk Homeostasis Theory: all behaviors hold some level of risk and the challenge of driving is to maximize the overall benefits of the behavior. The driver learns to adjust behaviors when a discrepancy is observed between the observed level of risk and the target level of risk. (Burns and Wilde 1995; Wilde 2002) Target Risk Theory: an adaptation of risk homeostasis that necessitates the adjustment of driving behavior so that perceived risk is in line with target risk. (Wilde 2002)

25 The biochemical mechanisms coupled with Wilde’s Homeostasis Theory suggests an intrinsic biological mechanism at play in the relationship between risk taking and behavior of all types.

26 Irrespective of the viability of theoretical explanations, we can graphically summarize the biochemical and behavioral commonalities between credit scores and insured loss generation....

27 Biological and Psychobehavioral Correlates of Risk Taking, Credit Scores, and Automobile Insurance Losses Stress Risky Driving BehaviorRisky Financial/Credit Behavior Antisocial Behavior Depression Exploration Arousal Amplifies reaction to stimuli Impulsive driving decisions Inattention to details or the environment (road conditions, road signs, traffic conditions) Impulsive financial/purchase decisions Inattention to details or the environment (interest rates, penalty fees, payment due dates) Credit Score Credit History Insurance Losses Distractibility/ lack of focusDistractibility/lack of focus (no financial planning, no savings) Irresponsibility regarding driving behavior (drinking, speeding, light/sign running, unsafe lane changes Irresponsibility regarding financial or credit obligations (extravagance, overextended on credit cards) Risk Appraisal Judgments Risk Perception Judgments Impulsivity SENSATIO N SEEKING Low Levels of Cortisol Low Levels of Serotonin High Levels of Testosterone High Levels of Dopamine High Levels of Norepinephrine Low Levels of MAO-A Corticosterone Putting All The Relationships Together, We Have...

28 Thank you very much for your attention. Questions? Comments?


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