When consumers are looking to borrow money, whether it’s for a credit card, homeownership, or a car loan, their past information is used by financial institutions to determine how best and at what level. provide access to the capital they need.
Risk-based pricing, where lenders offer different consumers different interest rates or other loan terms based on the estimated risk that consumers will not repay their loans, allows financial companies to use analytics to better assess the 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, assesses how risk-based pricing and the use of data lead to better outcomes for consumers by increasing access to financial service products and allowing pricing of these products to be calibrated in a manner accurate and appropriate for borrower or repayment risk.
The benefits of risk-based pricing are substantial and have enabled lenders and insurers to better serve consumers across the spectrum of risk. Through our research, we have found the following to be true:
- Consumers are better off in a risk-based pricing system than in a flat pricing system.
- Credit scores, credit-based insurance ratings, and other risk-based pricing factors have been proven to accurately predict risk in an unbiased manner.
- Minority and low-income households have made the greatest improvements in terms of assets and access to capital.
- Companies are innovating and using alternative data to reduce the invisible credit population and improve the credit scores of those who currently have it.
- Incorporating more predictive data, not less, into risk-based pricing models generates positive economic benefits.
Efforts to advance equal opportunities 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 the full potential of minorities and underserved communities have not yet been fully grasped and realized in America. All Americans should have a fair chance to earn their success, rise up on their merit, and live out their own American dream.
Last year, the United States Chamber of Commerce launched the Equal Opportunities Initiative develop real and lasting solutions to help close the racial-based opportunity gap in six areas: education, employment, entrepreneurship, criminal justice, health and wealth. Inequalities in these six areas perpetuate wider inequalities in our society, hamper individual and business success, and hamper economic growth. In early 2021, the US Chamber of Commerce created working groups around six main pillars as well as access to capital and supplier diversity. These conversations bring together businesses, policy experts and others to share and discuss strategies to advance these issues and solutions in the years to come, including opportunities to strengthen the risk-based pricing system.
Using risk-based pricing enables lenders and insurers to better serve consumers across the spectrum of risks in a fair market. High-risk consumers can access credit and insurance products to seize economic opportunities, while low-risk consumers are rewarded with lower costs to access capital. As seen in recent decades, consumers of all economic and demographic groups in the United States have improved their risky behavior to take advantage of lower costs of capital.
US policymakers should continue to strengthen 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 the data 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 lower cost credit. Policymakers should support policies that help Americans improve their financial health, which, in turn, will increase economic opportunities for these people.
- Support further research. Using additional data helps Americans improve their credit rating. 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 groups and the private sector on efforts to increase fairness in the risk-based pricing system while leveraging aspects that work.