Last week the Consumer Financial Protection Bureau (hereafter “CFPB”) published a study that suggests the way medical collections are treated by credit scoring systems may overly penalize consumer’s credit scores.
The study goes on to suggest scoring systems underestimate the credit quality of consumers who owe medical debt and that even when paid, consumers aren’t being rewarded with enough increase in their scores.
To set the landscape a bit, medical service providers commonly outsource the collection of their unpaid bills to 3rd party collection agencies.
Those collection agencies routinely place those collections on the credit reports of the debtor consumers. And, those collections can lead to lower credit scores and remain on credit files for seven years.
Medical collections are coded as such, meaning it’s very easy to identify a collection caused by a medical bill versus, say, a defaulted credit card account.
According to the CFPB, some 99.4% of medical debt reported to the credit bureaus is reported by collection agencies.
The FICO Story
Current versions of the FICO credit scores, which are the most commonly used, treat all collections the same way whether medical, non-medical, paid or unpaid.
Collections are considered to be major derogatory items and can, but don’t always, cause lower credit scores.
Still, it appears that both FICO and VantageScore recognize the diminished value of medical related collections and are already changing their scores accordingly.
In FICO’s latest credit score generation, called FICO Score 9, medical collections, including paid medical collections, will have a smaller impact than non-medical collections, according to Anthony Sprauve, FICO’s Senior Consumer Credit Specialist.
The VantageScore Story
The newest version of the VantageScore credit score (VantageScore Version 3.0) ignores collections, of all types, that have a zero balance but does consider all collection types that are unpaid.
That means if you or your insurance company pays or settles a collection it will cease to be considered by their credit score.
According to a spokesperson for VantageScore Solutions, “Using more granular data in unique combinations that emphasized unpaid collections, we created variables that delivered greater predictive strength than paid collection variables.”
What this means is they were able to extract more value from unpaid collections, which allows them to bypass paid collections.
The Medical Debt Responsibility Act
The CFPB found that medical collections are not as indicative of elevated credit risk as non-medical collections.
They also found that paid medical collections are not as indicative of elevated credit risk unpaid medical collections.
This would suggest credit-scoring models should either discount medical collections altogether or, at the very least, award the consumer with more score points once the medical collection has a zero balance.
These findings, which aren’t terribly surprising, lend support to a piece of proposed legislation called the Medical Debt Responsibility Act (hereafter “MDRA”).
The MDRA has been proposed for the last several years but keeps going nowhere.
If it were to become law the MDRA would require that the credit bureaus remove all medical collections within 45 days of being paid off.
The MDRA, which seems like a good deal for consumers, is too broad in its verbiage.
It doesn’t consider the fact that some people actually default on medical debt for reasons other than insurance filing snafus.
It also doesn’t consider the fact that medical debt is predictive of elevated credit risk, just not as much as some credit scores think.
The purpose of the CFPB study is unclear. It does not propose any “next steps” or action items.
It also doesn’t suggest that credit scoring models change their treatment of medical collections, paid or unpaid.
John Ulzheimer is the Credit Expert at CreditSesame.com, and a credit blogger at Mint.com, CreditCardInsider.com and the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO and Equifax, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. You can follow John on Google+ or Twitter here.