Best practice in data & scoring

Dr Paul Russell Director Analytical Solutions

© Experian Limited 2007. All rights reserved. Experian and the marks used herein are service marks or registered trademarks of Experian Limited. Other product and company names mentioned herein may be the trademarks of their respective owners. No part of this copyrighted work may be reproduced, modified, or distributed in any form or manner without the prior written permission of Experian Limited. Confidential and proprietary.

Agenda
 Some themes  Analytics and the customer life cycle  The role of scoring  Building a scorecard  Using scoring systems  Risk management infrastructure

© Experian Limited 2007. All rights reserved. Confidential and proprietary.

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Themes

 Best practice is often discussed but almost never seen

 Do the simple things well

 Risk management is more than just a scorecard

 The same principles apply across the credit lifecycle

© Experian Limited 2007. All rights reserved. Confidential and proprietary.

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13 ways to grow bad debt
Credit process Target step population Customer acquisition

Description 1. Identifying potential customers; 2. Selling credit products to new customers; 3. Identifying the credit risk of the customer and the proposed transaction; 4. Identifying the risk of fraudulent application 5. Deciding whether to accept or decline the transaction; 6. Deciding, for accepted transactions, on the terms, e.g., credit amount, pricing. 7. Reviewing the customers facilities (e.g., credit limits, price, etc.); 8. Cross-selling new products to the customers; 9. Ensuring good customers are retained; 10. Identify fraudulent transactions. 11. Identifying self-cure customers; 12. Rehabilitation of potentially good customers; 13. Work-out customers where relationship is broken.
© Experian Limited 2007. All rights reserved. Confidential and proprietary.

New customers

Customer management

Existing, nondelinquent customers Existing, delinquent customers

Collections

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196 1. Confidential and proprietary.Why is credit risk management important? 2.382 1.374 Profits 836 924 740 804 764 Impairment charges 1998 1999 2000 2001 2002 2003 2004 2005 2006 © Experian Limited 2007.520 1.230 1.094 802 676 478 288 340 2.986 European consumer finance business. All rights reserved. Profit Before Tax and Impairment Charges ($m) Get it right and it can support phenomenal value creation 1.522 1. 5 Source: Annual Reports .

) that maximise profit Software tools to automate the calculation of the above scores and credit strategies on-line on high volumes. Statistical Models Credit strategies Implementation tools Evaluation tools 6 . LGD). All rights reserved. Confidential and proprietary. credit bureaux) Risk models (PD. fraud models (application and transaction fraud) and revenue models Business rules that translate the outcome of statistical models in credit decisions (accept/decline.5 core components Component Data Description Application data (for new customers) Account behaviour data (for existing customers) External data (e.g. credit limits. with a high degree of flexibility to change credit strategies “on the fly” Software tools to evaluate the performance of statistical models and credit strategies. etc. price. and accuracy of implementation © Experian Limited 2007..

Agenda  Some basic themes  Analytics and the customer life cycle  The role of scoring  Building a scorecard  Using scoring systems  Risk management infrastructure © Experian Limited 2007. All rights reserved. 7 . Confidential and proprietary.

Analytics and the customer life cycle Solicitation Application Customer management Collections Debt recovery Population Information Analytics touches every part of the customer lifecycle  Analytics touches every part of the customer life cycle  Amount of information about the customer grows as the relationship advances through the customer life cycle © Experian Limited 2007. Confidential and proprietary. 8 . All rights reserved.

Confidential and proprietary. 9 . All rights reserved.Analytics and the customer life cycle Solicitation • Channel preference • Contact history • Demographics • Location • Bureau data • Action outcomes • Costs Application • Channel • Product holdings • Demographics • Bureau data • Previous relationships • Account performance • Costs Customer management • Product holdings • Usage • Delinquency • Customer contacts • Preferences • Bureau data • Actions taken • Action outcomes • Costs Collections • Action history • Promises to pay • Promises fulfilled • Action outcomes • Bureau data • Costs Debt recovery • Action history • Promises to pay • Bureau data • Agents used • Promises fulfilled • Litigation outcomes • Costs © Experian Limited 2007.

Confidential and proprietary. 10 .Analytics and the customer life cycle Define Goals Agree objectives Understand results Assess Strategy Review Monitor Track progress against expectations Implement Design Build new strategy Plan Review Assess current challenger Ensure operational deployment © Experian Limited 2007. All rights reserved.

Confidential and proprietary. All rights reserved.Agenda  Some basic themes  Analytics and the customer life cycle  The role of scoring  Building a scorecard  Using scoring systems  Risk management infrastructure © Experian Limited 2007. 11 .

12 . Confidential and proprietary.The role of scoring  Credit scoring is a technique for predicting the future  This prediction can be anything of importance to the business x x x x x x x Arrears Fraud Profit Response Account closure Company failure Etc. All rights reserved.  All scoring is based on one key assumption: x The past predicts the future © Experian Limited 2007.

The role of scoring How does scoring work? • Example Scorecard Baseline Constant 800 Scorecards add and subtract points to a baseline constant according to individual’s or account’s data Scorecards are easy to apply and simple to understand The resulting score gives a prediction of future behaviour Scores are used to rank individuals to assign the best actions Applicant Age in Years < 22 22 . Confidential and proprietary. All rights reserved. … © Experian Limited 2007.25 26 – 40 41 – 55 > 55 -50 -20 0 +30 0 • Worst Status L6M (on all Accounts) 0 1-2 3+ 0 -45 -100 • Joint Applicant Present Y N +20 0 Etc. … • Etc. 13 .

14 . All rights reserved. Confidential and proprietary.) Take most appropriate action for each individual © Experian Limited 2007.The role of scoring – application scorecard • Consider a scorecard built to predict whether a new applicant for a credit product will default in the next 12 months This scorecard is used when a new customer applies… • Application Form Data Scorecard Score External Data (Bureau etc.

Confidential and proprietary. All rights reserved.scores can drive actions Low Score / High Risk Proportion of Applicants A pplication Score High Score / Low Risk Extremely Low Risk High Risk Extremely High Risk Reject Reject or price to cover the high expected loss Standard Risk Accept on standard terms Consider for crosssell of other products 15 © Experian Limited 2007. .The role of scoring .

16 .The role of scoring . Confidential and proprietary.benefits  Best use of data  Objective  Consistent  Automation  Control  Reduced losses © Experian Limited 2007. All rights reserved.

17 . All rights reserved. Confidential and proprietary.Agenda  Some basic themes  Analytics and the customer life cycle  The role of scoring  Building a scorecard  Using scoring systems  Risk management infrastructure © Experian Limited 2007.

Confidential and proprietary.Building a scorecard – 3 requirements  Development sample – the historical data on which the scorecard will be built  Outcome – what we are trying to predict  Modelling methodology – the statistical tool that will help us form our scoring model THEN The recent past Some time later Development Sample Statistical Model Outcome Scorecard © Experian Limited 2007. All rights reserved. NOW 18 .

All rights reserved. Confidential and proprietary. THEN 19  Representative .Is my sample any good? x x x Products Business cycle The future The recent past  Robust x Development Sample Volumes  Mature Is the outcome reliable? © Experian Limited 2007.

All rights reserved. Confidential and proprietary. 20 THEN .Building a scorecard – the development sample • • This data can come from a number of sources All relevant data should go into the development sample The recent past Development Sample Application Form Credit Bureau Data Information on the individual’s other credit commitments Historical Account Behaviour Information on the historical behaviour on the account Other Account Information Information on the historical behaviour on other accounts with the same lender Information collected from the applicant at the application point © Experian Limited 2007.

Now © Experian Limited 2007. revenue.) More commonly it is dichotomous . Confidential and proprietary. Outcome Good THE FUTURE Bad Observation . etc. loss given default. Outcome . All rights reserved.yes/no x x x x Will this applicant default? Is this transaction fraudulent? Will this company fail? Etc.Prediction 21 NOW .Building a scorecard – the outcome This is the behaviour that we are trying to predict • • Can be a continuous variable (profit.

judgements or court judgements or defaults defaults © Experian Limited 2007. court No bankruptcy. Confidential and proprietary. All rights reserved. NOW 22 .What are we trying to predict? Bad Good Consumer Limited business Non-limited business 3 payments in arrears Failed Not 3 payments in arrears Still going Outcome Bankruptcy.

Building a scorecard – the statistical model  Many statistical tools available  Data is the most important factor Statistical Model Observation Data Outcome Statistical Model Scorecard Statistical tool needs to be:  Powerful – to get the best prediction from the data  Flexible – can handle varying data types and outcomes  Interpretable – easy to understand and to overlay business intelligence  Transparent – should be non-’black box’ for regulatory reasons and to ensure understanding © Experian Limited 2007. Confidential and proprietary. 23 . All rights reserved.

Confidential and proprietary.the statistical model  Linear regression Reality Statistical Model  Logistic regression  Artificial neural networks  Etc  Other things being equal the choice of algorithm has relatively little impact on the ultimate power of the model x x x x x x x x x x x x x x x x x x x x x Prediction © Experian Limited 2007. 24 .Building a scorecard . All rights reserved.

Building a scorecard – assessing the model Does the model solve the business problem? Statistical Model  Discrimination – the power to polarise individuals between good and bad .Gini statistic & Kolmogorov-Smirnov statistic  Accuracy – how much of the variability of the outcome is explained by the model  Validation – ensures that over-modelling has not occurred or that an anomalous sample has not been used  Improvement – the new model should outperforms the existing model © Experian Limited 2007. All rights reserved. 25 . Confidential and proprietary.

Confidential and proprietary.Agenda  Some basic themes  Analytics and the customer life cycle  The role of scoring  Building a scorecard  Using scoring systems  Risk management infrastructure © Experian Limited 2007. All rights reserved. 26 .

     Growing the market share Reducing bad debt Increasing automation Maximising response for given marketing cost Combating fraud © Experian Limited 2007. All rights reserved. which is used to aid the decisioning  The decisions a company makes determine its strategy  It is the aims and strategy of the business that must be considered when deciding how to use a scoring system.Using scoring systems DATA SCORE CARD DECISIONS STRATEGY  The data feeds the scoring system.g. Confidential and proprietary. e. 27 .

The role of scoring . Confidential and proprietary. . All rights reserved.scores can drive actions Low Score / High Risk Proportion of Applicants A pplication Score High Score / Low Risk Extremely Low Risk High Risk Extremely High Risk Reject Reject or price to cover the high expected loss Standard Risk Accept on standard terms Consider for crosssell of other products 28 © Experian Limited 2007.

7 10.7 10.800 801 – 850 851 – 900 901 – 950 ≥ 951 TOTAL # Goods 500 700 815 1008 976 950 1000 1050 960 1000 8959 # Bads 500 350 163 84 61 38 25 21 16 10 1268 GB Odds 1 2 5 12 16 25 40 50 60 100 7.Using scoring systems .1 % Applicants 9.5 9.0 10. All rights reserved.8 10.9 100 • • Score distribution is obtained by applying the score to the development sample Gives us a prediction for new applicants falling into a given score range © Experian Limited 2007. 29 .5 9. Confidential and proprietary.the score distribution Score Band ≤ 400 401 – 550 551 – 650 651 – 700 701 – 750 751 .1 9.3 9.6 10.

8 10.9 100 ACCEPT WITH XSELL ACCEPT REFER REJECT Score + Policy Rules + Terms of Business = Strategy © Experian Limited 2007.3 9. 30 .6 10.the score distribution Score Band ≤ 400 401 – 550 551 – 650 651 – 700 701 – 750 751 .1 9.7 10.0 10.5 9.5 9. All rights reserved.7 10. Confidential and proprietary.1 % Applicants 9.800 801 – 850 851 – 900 901 – 950 ≥ 951 TOTAL # Goods 500 700 815 1008 976 950 1000 1050 960 1000 8959 # Bads 500 350 163 84 61 38 25 21 16 10 1268 GB Odds 1 2 5 12 16 25 40 50 60 100 7.Building a scorecard .

Agenda  Some basic themes  Analytics and the customer life cycle  The role of scoring  Building a scorecard  Using scoring systems  Risk management infrastructure © Experian Limited 2007. Confidential and proprietary. 31 . All rights reserved.

Confidential and proprietary.. All rights reserved. Deployed in: Origination  Application processing  Portfolio Management  Customer level decisioning  Collections  Authorisations  Intelligent Messaging  Event Management  Basel II Stress testing  …. 32 .Implementation – the Business Rules Engine Data Rules execution (Decision Agent) Rules Definition (Strategy Design Studio) Results © Experian Limited 2007.

All rights reserved. Provision of hand-off files.The unsecured lending origination process A full range of client options and interfaces for channel independence and data accuracy Online links to gather data about existing relationships and customer behaviour Gather & validate application data Invoke enrichment strategy Credit bureau links Gather existing customer information Get decision & terms of business Business-driven scoring & decisionmaking Comprehensive workflow capabilities and provision of relevant data for users Detect application fraud Application screening and data matching Handle referrals and manual procedures Get policy decision & enrichment strategy Business-driven scoring and decisionmaking Implement final decision Automated account set-up. Letter and e-mail production © Experian Limited 2007. 33 . Confidential and proprietary.

Segmentation. Scorecards. Account Decision Engine Evaluation Optimisation Reporting Strategy Implementation Rule Definition Data Manager © Experian Limited 2007. All rights reserved.g. Strategies and Champion Challenger Defines Business logic. Confidential and proprietary. Authorisation System etc Active History Extract FeedbackVariables e. Segmentation.Implements Business logic. Strategies and Champion Challenger Analytical ResultsData Mart HOS T Management System. Operational environment Strategic business34 environment . Scorecards.

Confidential and proprietary..strategy optimisation There are disadvantages to traditional champion/challenger testing… • The time frame for observing results can be long • It can be hard to design the next step • The result can become a “semi-random walk”. may no longer be appropriate for another time period – things change Champ ion Decision strategy “deploy-learndeploy” process Challeng er 1 Using performance data enables better decisions. but is also more complex to combine all the decision influences to maximise value Challeng er 3 Challeng er 4 Challeng er 2 Time © Experian Limited 2007. Value We want to get there with the first challenger ! Challeng er n The challenger strategy proven in one time period.Beyond scoring .. Influence due to: • Macro-economics? • Use of intuition? • Misunderstanding? 35 #35 . All rights reserved.

g.Developments in analytics . credit risk score “Heuristic” cut-offs assigned using good:bad odds Segmentation based on predictive model dimensions: e. risk and revenue “Subjective” judgment used to manage trade-offs • • • • Experience and intuition Trial and error • Underlying decision complexity © Experian Limited 2007. mathematical goal maximisation • • single predictive model e.strategy optimisation The next step… Incremental benefit ROI Some organisations are still here Most are here Optimised Strategies Elaborate Strategies • Scoring Manual X X X X X X X XX X X XX X X X X X X XX X XXX XX X XXX X XXX X X XXX X X X X Allocates optimal action for each customer within constraints Objective. Confidential and proprietary. 36 #36 .g. All rights reserved.

37 .Stage 1: build the infrastructure  Centralisation of credit decisioning  Set-up of IT tools required to automate credit risk and market management processes and the interaction between front line and back office  Development of decision support tools  Development of credit / marketing databases Automate the processes © Experian Limited 2007. Confidential and proprietary. All rights reserved.

Stage 2: fine-tune for performance  Fine customer segmentation based on customer profile. 38 . All rights reserved. product holding and behavior data  Advanced credit and marketing databases drive increased sophistication in statistical models development  Customer interactions for risk and marketing are proactively initiated at all key points  Strategies are designed at customer-level Automate the decisions © Experian Limited 2007. Confidential and proprietary.

operations. Confidential and proprietary. 39 . All rights reserved. sales. finance Optimize the decisions © Experian Limited 2007.Stage 3: optimize for excellence  Infrastructure enables total proactive control of the business – decision analytics becomes a way of life  Risk and marketing strategies are centrally designed based on advanced statistical techniques and drive customer profitability  Decision analytics is well structured and integrated across business functions including risk. marketing.

reviewed and improved? Processes well defined and automated Processes regularly reviewed and refined. 40 . Champion/challenger a way of life Processes fully support profit-driven strategy. not second scorecard Education on strategy review process. All rights reserved. flexible are they? How marketing and finance easy is it for business user working together? How to change processes and Organisation are operational and strategies? strategic decisions taken? © Experian Limited 2007. ability to optimize credit strategies Ability to review and modify credit strategies ‘on the fly’ “a world-class consumer finance company” How are credit policies and strategies defined. and are integrated across functions Ongoing knowledge improvement Full suite of scorecards.The Road Map Build the infrastructure Strategy Credit policy in place Fine-tune for performance Profit driven credit strategy in place and reviewed regularly Optimize for excellence Monthly review of credit strategies. Generate management functions key KPI’s What credit management tools are used? How How are credit risk. decision engine used to Ensure clear assignment of control terms of responsibilities for risk business. and what is the degree of automation? Include all available data into the process. Confidential and proprietary. Focus underwriter on “key” review. Little manual intervention Processes How well defined and the processes. fully understanding the use of MIS Profit-driven organisation across functions Create strategy review cross-functional team How well do staff understand all profit drivers? What is the degree of expertise in credit scoring and decision science? Knowledge Tools Scorecards in place for all critical segments.

All rights reserved. Confidential and proprietary. 41 .Conclusions  It all starts with data  Scorecards are important  Strategy is more important  Implementing the strategy properly is vital  If you don’t monitor you’re wasting you time  Risk management is a never-ending journey © Experian Limited 2007.

No part of this copyrighted work may be reproduced. or distributed in any form or manner without the prior written permission of Experian Limited. modified. Confidential and proprietary. . All rights reserved.Best practice in data & scoring Dr Paul Russell Director Analytical Solutions © Experian Limited 2007. Experian and the marks used herein are service marks or registered trademarks of Experian Limited. Other product and company names mentioned herein may be the trademarks of their respective owners.

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