Underwriting guidelines refer to the process members of the insurance industry use to determine whom they will insure. Because insurance deals in risk, insurance companies create a set of guidelines to determine the circumstances under which they will assume that risk and offer insurance to a new customer, what rates to set, and when potential customers become too risky to insure.

Although companies are prohibited from using factors like race in their guidelines as a form of illegal "unfair discrimination," guidelines involve the use of particular facts about people in order to measure risk factors and set rates. This means that some form of discrimination is necessary and legal.

Processes such as redlining, which have prevented non-Whites from accessing property wealth, relied on federal underwriting policies and have contributed to the growing racial wealth gap in the country. In recent years, questions about what counts as unfair discrimination have received increasing attention, especially after protests over the death of George Floyd.

Key Takeaways

  • Insurance companies use underwriting guidelines to determine insurance rates.
  • Although companies are prevented from using factors such as race in their guidelines as a form of “unfair discrimination,” guidelines involve using specific facts about people to set rates.
  • Prominent forms of historically biased insurance rules that have affected the impact of the industry include redlining, racially restrictive covenants, race-based insurance premiums, and what advocates say are subtle proxies for unfair discrimination, such as using ZIP codes and credit scores to price auto insurance.
  • In recent years, regulators and members of the insurance industry have proposed methods and policies aimed at lessening discrimination.

Existing Discrimination

In response to the George Floyd protests, the National Association of Insurance Commissioners (NAIC), the standard-setting organization for the insurance industry, held a special session on race to scrutinize the connection between insurance and racial discrimination. Though overt racial discrimination has become less common, members said that subtle forms of discrimination persist, especially in the use of big data. Moreover, as discussed below, lawsuits and investigations have alleged that long-standing discriminatory practices, such as redlining and race premiums, have continued to affect the industry into the 21st century.

The categories presented here are not exhaustive. Health insurance, for example, has been another area of concern regarding discrimination, particularly with federal rules such as 2020's Nondiscrimination in Health and Health Education Programs or Activities, Delegation of Authority. This ruling was decried by California Insurance Commissioner Ricardo Lara, among others, as a roadblock to accessing healthcare for LGBTQ+ people, people with disabilities, and anyone whose primary language isn't English.

Types of Discrimination

Underwriting guidelines rely on a form of discrimination based on risk profiles. They are created to separate people into high- and low-risk categories in order to decide how much an insurance company should charge a customer for a premium and also encourage customers to reduce their risk behaviors. Though this is considered acceptable, the history of underwriting is flush with examples of discrimination that are considered unacceptable, known as unfair discrimination.

Under American law, unfair discrimination cannot be used in underwriting guidelines. Unfair discrimination refers to guidelines that target protected classes, such as race, national origin, sex, or religious belief. The actual form that this discrimination takes can vary, ranging from offering inferior insurance coverage to simply not responding to insurance applicants because of their perceived characteristics. 

Disparate Impact vs. Unfair Discrimination

Conversations about algorithmic modeling in insurance tend to conflate "unfair discrimination" and "disparate impact," which are legally separate concepts, according to Susan T. Stead of Squire Patton Boggs, LLP. Disparate impact, Stead says, is a legal method to prove discrimination in the absence of "overt discrimination" against a protected class, and traces back to a 1971 Supreme Court case. Unfair discrimination, on the other hand, is when the same risks are treated differently because of a factor not related to risk; it is banned by laws in every state.

A legal review from the University of Michigan Law School in 2013 found that anti-discrimination laws "vary a great deal" by state and across insurance types. It also reported that a "surprising" number of jurisdictions didn't have specific laws to restrict unfair discrimination based on race and suggested that the federal government may need to take a larger role in regulating discrimination in insurance based on race.

Notable Moments in Underwriting Guidelines Discrimination

Redlining and housing

Redlining, a form of discrimination that has received popular attention in recent years for its continued effect on inequality, traces back to the era of the administration of Franklin Delano Roosevelt.

During that time, the federal government began backing home mortgage insurance as part of its strategy to increase the housing supply and grow the White middle class. Using color-coded maps from the Home Owners' Loan Corp., the Federal Housing Administration (FHA), created in 1934, categorized the associated levels of risk for investments in any given neighborhood, which classified neighborhoods of color as too risky for mortgage insurance. In short, they shunted resources, including loans and insurance, away from communities of color.

Underwriting guidelines from the FHA would spell out the explicitly racial component of these maps, such as in the statement that "incompatible racial groups should not be permitted to live in the same communities." The effects of these maps, along with racially restrictive covenants that kept communities of color from accessing neighborhoods, were devastating and can still be observed.

Since then, the more explicit forms of this discrimination have become illegal. The 1948 Supreme Court case Shelley v. Kraemer, for instance, found that racial covenants cannot be legally enforced because they violate the 14th Amendment. Importantly, the Civil Rights Act made many forms of racial discrimination illegal and would have an impact, in particular, on race-based premiums in life insurance, discussed below.

Several other developments in this area would touch on redlining specifically. The 1968 Fair Housing Act, which was passed after the assassination of Martin Luther King Jr., disallowed redlining based on race. The 1965 Housing and Urban Development Act, which was meant to co-ordinate federal housing programs, also established grants for poor homeowners, as well as rent subsidies for the elderly and physically challenged, greater access to public housing, and favorable loans for military veterans. Lenders have to disclose census information regarding their lending because of the 1975 Home Mortgage Disclosure Act (HMDA).

Despite this, there are allegations that this discrimination still occurs in practice. For example, a series of lawsuits from New York alleged that redlining practices continued into the 21st century.

Race and life insurance

Life insurance in general has a history of reinforcing racial hierarchies in the U.S., according to an article by Mary L. Heen in the Northwestern Journal of Law & Social Policy. After Reconstruction, she writes, the insurance industry pointed toward high mortality rates and innate racial differences to justify life insurance that offered emancipated enslaved people only two-thirds of the benefits that were offered to White people.

Companies with race premiums tended to ignore any statistics that didn't fit preconceived hierarchies when setting premium rates, such as the fact that women had a lower mortality rate, suggesting that the risk involved was not the main motivating factor in setting premiums. (According to librarians from the NAIC, the Travelers Insurance Company would become the first company to offer life insurance at a lower rate for women than men in 1958.)

Such practices continued into the 20th century. In 1940, for instance, the NAIC published a study that looked into mortality rates by race, which insurers then used to set race-based premiums. The study would fuel discriminatory underwriting policies until sometime after the use of race was banned, according to NAIC-affiliated librarians.

Insurers at this time carried two sets of rate books, one of which reflected higher rates for Blacks, who were mostly purchasing "industrial life insurance" to cover burial costs. Not only did the policies offered to Blacks cover less, but they were also more expensive, charging policyholders a premium as much as 30% to 40% higher, according to George Nichols III, president and CEO of the American College of Financial Services.

Race-based premiums would remain legal until 1964, during the Lyndon B. Johnson presidency, when pressure from civil rights activists led to the passage of the Civil Rights Act. Beginning in 2000, the industry paid out $556 million in fines and restitution concerning lawsuits related to millions of race-based premiums that were sold in the 20th century.

Auto insurance

Auto insurance policies first appeared in the U.S. in 1897. In 1938, New Hampshire passed a state insurance law mandating that insurers offer specific kinds of coverage, known as an assigned risk plan, making it the first state to do so. No-fault insurance came later, with Massachusetts introducing it first in 1970. Guaranteed access to auto insurance would also come in the 1970s. In 1976, South Carolina passed a law that guaranteed auto insurance access to everyone within its jurisdiction who was eligible, according to the NAIC.

Other updates in the 1970s would also touch on access to auto insurance. Some major items from that decade and the next include:

  • In 1977, a state report from the Michigan Insurance Bureau recommended making underwriting standards for auto insurance subject to the bureau's oversight to nix "subjectivity."
  • In 1978, Massachusetts created a statewide system for regulating auto insurance that banned using protected characteristics to set prices and guaranteed access.
  • In 1978, the Michigan Supreme Court found that mandates of no-fault coverage were unconstitutional.
  • In 1986, the Government Accountability Office (GAO) looked over auto insurance across the states.

In recent years, investigations have revealed that practices like redlining have persevered in subtle forms in the auto insurance industry. A 2017 investigation published in Consumer Reports that used payout data found disparate auto insurance prices in California, Illinois, Missouri, and Texas that its authors say cannot be explained by differences in risk, suggesting what they call a "subtler form of redlining."

In 2020, the Consumer Federation of America (CFA) reported that research from the organization had revealed ongoing discrimination in the auto insurance agency. According to the CFA, most auto insurance companies were using non-driving factors in a way that affected the rates of drivers with certain characteristics. "The companies will insist that they never ask for a customer’s race, but if they are serious about confronting systemic racism, it is time they recognize that their pricing tools use proxies for race that make government-required auto insurance more expensive for Black Americans,” says Doug Heller, an insurance expert for the CFA, in written materials.

Legislation has been proposed to limit discriminatory practices in auto insurance, such as HR 3693 and HR 1756, two bills from 2019 that tried to limit the use of income proxies and credit scores to set policy rates, though the bills never made it out of committee. The incorporation of credit scores in auto insurance began in 1995 with the Fair Isaac Corporation and ChoicePoint, and critics have argued that it is a "surrogate for redlining" and drives up premium rates for communities of color.

In 2021, Colorado passed a bill that protects a list of classes—including race, sexual orientation, and gender identity and expression—from discrimination in underwriting. The law will make insurance companies show that pricing strategies don't create unfair discrimination, which Heller said gave the state "the tools it needs to end discrimination and ensure auto insurance is priced fairly so that everyone can afford the coverage they need."

The use of algorithms

Sets of instructions known as algorithms, which insurance companies use to calculate insurance rates (as well as to trade stocks and manage asset liability, among other uses) can also contribute to discrimination in insurance underwriting. In 2020, as part of a Congressionally appropriated initiative to modernize the FHA, the agency launched an algorithmic underwriting system for single-family forward mortgages. It was the first such system launched by that government agency, which the FHA said would help to streamline the mortgage process.

However, questions about the actual impact of algorithmic insurance processes persist.

Advocates say that these algorithms promote or extend bias, and this has led to regulatory proposals to address the issue. One was the 2020 Data Accountability and Transparency Act, which would have created a federal agency to protect privacy and would also have banned the use of personal data to discriminate against protected classes. It also homed in on underwriting practices specifically and would have required continuous testing for bias in the use of such algorithms. When bias was found, according to analysts interpreting the bill, it would have required proof that the algorithm was necessary, that its function couldn't be accomplished through another non-discriminatory means, and that the discrimination wasn't intentional. A new version of the bill, the Diversity and Inclusion Data Accountability and Transparency Act, was introduced in the House in March 2021.

Restrictions on algorithmic practices also exist at the state level. Regulators in New York, for example, prevent insurers from using algorithms that would “have a disparate impact,” according to a 2019 letter from the New York Department of Financial Services to insurers authorized to write life insurance in the state of New York. However, regulatory analysts have written that insurers in the state cannot collect information on legally protected classes, somewhat complicating this rule by making it hard to figure out what effect an algorithm is having. Other states—including California, Connecticut, Illinois, New Jersey, Michigan, Maryland, and Massachusetts—either have enacted or have considered some form of restriction on the inclusion of personal information in underwriting, ranging from restrictions on the use of genetic data in life insurance to considering education, job, and ZIP codes as criteria.

The Bottom Line

NAIC members present at the 2020 session on race recommended several ways to redress existing inequalities, such as increasing minority presence in the industry, educating consumers, and regulating big data to ensure transparency, protect privacy, and deter discrimination. The NAIC has also established a special committee to address these issues.

What Criteria Do Insurance Underwriters Consider?

The specifics differ from company to company, but insurance underwriters search for the risk factors identified by their company in its underwriting guidelines. These can include an old house, a swimming pool, or, according to the Maryland attorney general’s office, too much clutter in the home.

What Is Unfair Discrimination in Insurance?

Unfair discrimination happens when the prices for insurance aren't based on relative risk but on other factors, such as a person's race.

What Is Insurance Redlining?

Redlining refers to credit discrimination based on the area in which someone lives rather than the risk that offering them credit would carry.