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When consumers are looking to borrow money, whether it be for a credit card, homeownership, or an auto loan, their past information is used by financial institutions to determine how best and at what level to provide the access to capital they need.
Risk-based pricing, where lenders offer different consumers different interest rates or other loan terms based on the estimated risk that the consumers will fail to pay back their loans, allows financial companies to use analytics to better assess risks in order to offer innovative products at lower prices for consumers.
A recent report from the Center for Capital Market Competitiveness (CCMC), The Economic Benefits of Risk-Based Pricing for Historically Underserved Consumers in the United States, evaluates how risk-based pricing and the use of data results in better outcomes for consumers by increasing access to financial services products and enabling the pricing of these products to accurately and appropriately calibrate for borrower or repayment risk.
The benefits of risk-based pricing are far reaching and has allowed lenders and insurers to better serve consumers across the risk spectrum. Through our research we found the following to be true:
- Consumers are better off in the risk-based pricing system than in a uniform pricing system.
- Credit scores, credit-based insurance scores, and other risk-based pricing factors are proven to accurately predict risk unbiasedly.
- Minority and low-income households have realized the greatest improvements in assets and access to capital.
- Companies are innovating and using alternative data to reduce the credit-invisible population and improve credit scores for those who currently have them.
- Incorporating more predictive data, not less, into risk-based pricing models generates positive economic benefits.
Efforts to Advance Equality of Opportunity for All
While the benefits of risk-based pricing are clear, there are undoubtedly opportunities to strengthen the ecosystem. We know that the general economic opportunity and full potential for minorities and underserved communities has yet to be fully embraced and realized in America. All Americans should have a fair chance to earn their success, rise on their merit, and live their own American Dream.
Last year, the U.S. Chamber of Commerce launched the Equality of Opportunity Initiative to develop real, sustainable solutions to help close race-based opportunity gaps in six areas: education, employment, entrepreneurship, criminal justice, health, and wealth. Inequalities in these six areas perpetuate broader inequalities in our society, hold back individual and business success, and hinder economic growth. In early 2021, the U.S. Chamber of Commerce established task forces around six main pillars as well as access to capital and supplier diversity. These conversations are bringing together business, policy experts, and others to share and discuss strategies to advance progress on these issues and solutions in the years to come—including opportunities to strengthen the risk-based pricing system.
The use of risk-based pricing allows lenders and insurers to better serve consumers across the risk spectrum in a fair marketplace. High-risk consumers are able to access credit products and insurance to pursue economic opportunities while low-risk consumers are rewarded with lower costs to access capital. As seen over the past several decades, consumers across economic and demographic groups in the U.S. have improved their risk behavior to enjoy lower costs of capital.
U.S. policymakers should continue strengthening the existing risk-based pricing system, and we recommend the following policy proposals to support these efforts:
- Support the use of more data in risk-based pricing models. The more predictive data that is included in risk-based pricing models, the more accurately companies can predict risk.
- Support policies that improve the financial health of all Americans. In risk-based pricing, consumers’ credit scores improve as their financial health improves. With higher credit scores, consumers enjoy increased access to credit at lower costs. Policymakers should support policies that help Americans improve their financial health, which, in turn, will increase economic opportunities for these individuals.
- Support additional research. The use of additional data helps Americans improve their credit scores. However, little research exists on the barriers preventing or discouraging companies from incorporating alternative data into their risk-based pricing models.
The Chamber looks forward to working with policymakers, consumer advocacy groups, and the private sector on efforts to increase equity in the risk-based pricing system while leveraging the aspects that work.