Texas insurance code allows race neutral credit scoring, justices tell California court

Steve Korris Jun. 14, 2011, 3:00am


AUSTIN – Houston homeowner Patrick Ojo dodged Texas justice by starting a class action against his insurer in California, but Texas justice caught up with him.

On May 27, the Supreme Court of Texas rejected his claim that Farmers Group discriminates against African-Americans by factoring credit histories into premiums.

The Justices resolved the dispute at the request of federal appeals judges in San Francisco, who couldn't decide how to apply Texas law.

Ojo didn't allege intentional discrimination, arguing instead that the Texas insurance code prohibits race neutral pricing schemes that produce disparate results.

Justice Paul Green wrote, "However, nothing in the insurance code prohibits the use of race neutral credit scoring."

"In fact, the code requires that the factors used in credit scoring to price insurance be race neutral, or not based on race," Green wrote. "The nature of Ojo's disparate impact claim presupposes that these factors are race neutral, which is exactly what the code requires."

All Justices agreed except Nathan Hecht, who did not participate.

Case background

Ojo sued Farmers Group and affiliates in 2005, at federal court in Los Angeles, Calif., under the Fair Housing Act.

Farmers Group moved to dismiss, and U.S. District Judge Margaret Morrow drafted an order granting the motion.

She found Texas legislators validated the use of credit information in insurance underwriting and rate making.

She wrote, "At the same time, the legislature took steps to protect consumers' interests by creating new obligations that insurers must satisfy in order to utilize credit scoring."

"Were Ojo's interpretation of the statutory language adopted, it would undermine the entire purpose of the legislation, which was to authorize credit scoring, and render meaningless the statutory and administrative scheme created to ensure that credit scoring models are actuarially sound," Morrow wrote.

She gave the draft to both sides, held a hearing, and saw no reason to change her mind.

Upon learning that Zurich Financial Services owned Farmers Group, she recused herself because she owned Zurich stock.

U.S. District Judge John Walter read her draft and a transcript of her hearing, and decided to file her draft as his order.

He gave Ojo 10 days to amend his complaint, and Ojo declined to amend it.

Walter entered final judgment that Ojo would recover nothing, and Ojo appealed.

U.S. District Judge Harry Pregerson and Senior Circuit Judge Myron Bright reversed Walter in 2009, finding he erroneously read the claim as a challenge to credit scoring.

"The most significant oversight was the district court's failure to consider that Texas's own Fair Housing Act prohibits disparate impact race discrimination," Pregerson wrote.

He wrote that Walter also failed to consider that under Texas insurance code, a rate is unfairly discriminatory if it is based in whole or in part on race.

Dissenting Circuit Judge Carlos Bea wrote that Texas insurance law, unlike the federal Fair Housing Act, makes it perfectly legal to use credit scores to price insurance policies.

He wrote that insurers may use them "even if doing so causes a disparate impact on racial minorities, so long as race is not used as a criteria in computing the credit scores."

He wrote that applying federal law would violate the McCann Ferguson Act, which provides state preemption of federal laws that invalidate or supersede state insurance law.

"In effect, Texas law has already decided that the use of credit scoring to price homeowners insurance constitutes a valid business necessity; a defendant does not have to prove such business necessity in each case," Bea wrote.

"Class action litigation is too expensive to allow a plaintiff to engage in discovery unless and until the plaintiff can at least in good faith allege the defendant has done something prohibited by law."

Farmers Group moved for review by all 11 circuit judges, and they granted it.

They studied the split decision and fashioned a riddle.

"If Texas law permits insurance companies to use credit scores even if the factors used to compute scores may have a racially disparate impact that could violate the Fair Housing Act, then allowing Ojo to sue defendants under the Fair Housing Act for this practice would impair Texas law," the judges wrote.

"On the other hand, if Texas law prohibits the use of credit score factors that could violate the Fair Housing Act on the basis of a disparate impact theory, then the Fair Housing Act would complement, rather than displace and impair, Texas law," they wrote.

They found no decisions from Texas appellate courts to answer their question, so they asked the Supreme Court of Texas.

The Justices found that legislators expressly provided protection from disparate impact in the labor code, but no such section appeared in insurance code.

"The Texas Legislature, well aware of how to create a cause of action for disparate impact discrimination, chose not to do so in the field of insurance, specifically with regards to the use of credit scoring," Green wrote.

He wrote that in 2004, insurance commissioner Jose Montemayor found an apparent relationship between credit score and insurance loss.

"The decision to either allow or prohibit the use of credit scoring in pricing insurance that creates disparate impacts properly rests with the Legislature," he wrote.

On June 6, in San Francisco, Calif., Ninth Circuit Chief Judge Alex Kozinski set a June 27 deadline for briefs addressing the Supreme Court decision.

Harriet Posner of Los Angeles, Calif., represented Farmers Group at the Supreme Court.

James Francis of Philadelphia, Pa., Andrew Friedman of Phoenix, Ariz., Barrett Litt of Los Angeles, Claif., John Stoia of San Diego, Calif., Sanford Svetcov of San Francisco, Calif., and John Yanchunis of Tampa, Fla., represented Ojo.

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