Many companies use credit-based scores to evaluate policy seekers. The perception is that a high score makes you a better risk and will therefore cause you to pay less for insurance, while a low score makes you more of a risk causing you to pay more for the same coverage. Studies have shown that credit scores are a good indication of how much a policy holder will cost an insurance company, though no one knows exactly why. The method is so controversial that Massachusetts, Hawaii, and California have banned the practice. Those of us who live in the other 47 states, where a vast majority of insurance companies use credit-based scores, need to understand these scores and the implications they have on our own insurance costs. This article will give you an idea of what’s involved with credit scoring by insurance companies and how you may be able to improve your own “insurance credit score” position.
Credit score and risk: A mysterious link
Lenders use regular credit scoring to calculate the likelihood of a consumer to repay a loan. Insurers use credit-based insurance scoring to decide how much you are likely to cost them in claims. While the complex methods differ between industries and among scoring companies, both systems are based on a statistical analysis of consumers’ credit reports.
No one knows exactly why credit scores are predictive of insurance risk. Nevertheless, the University of Texas, the Federal Reserve, and the Federal Trade Commission have conducted studies that conclude that there is indeed a correlation between credit characteristics and insurance losses.
Long before computerized credit-based insurance scores were invented, insurers manually reviewed credit information during their decision-making process, according to software and scoring giant FICO. Without the help of statistically valid predictive analytics, these insurers had to rely on the subjective perspective of individual underwriters, who scanned credit reports manually and tried their best to guess how risky a prospect was. Letting an algorithm determine how likely you are to cost your insurance agency money might feel strange; letting a tired underwriter make the same call may be worse.
How insurance companies use your credit information
When it comes to credit and insurance, it’s important to understand two things:
1) Credit-based insurance scores analyze credit report data in a different way than credit risk scores.
2) These scores are not the only factor in making decisions about whether or not to offer a policy and what its terms are.
Factors considered for credit-based insurance scores
- Payment History
- Outstanding Debt
- Credit History Length
- Pursuit of New Credit
- Credit Mix
Factors not considered for credit-based insurance scores, according to the National Association of Insurance Commissioners:
- Race, color, national origin
- Religion
- Gender
- Marital status
- Age
- Income, occupation or employment history
- Location of residence
- Any interest rate being charged
- Child/family support obligations or rental agreements
- Certain types of inquiries of your credit report like account review inquiries, employment inquiries, promotional inquiries from credit companies, etc.
- Whether or not a consumer is participating in credit counseling of any kind
- Any information not found in the credit report
While these factors do not affect your score, insurers will use information like application data, motor vehicle reports, claim histories, inspection reports, demographic data and other details to make decisions about your policy.
Improving your credit-based insurance score
Your insurance company is required to give you a notice that includes your score and the name and contact information of their credit reporting company. You may ask your insurance company why your application was denied, or get a free copy of your credit report.
You can also proactively check your credit report and correct any inaccuracies you may find. The Fair and Accurate Credit Transaction Act of 2003 (FACT Act) allows you to get a free credit report annually from Equifax, Experian and TransUnion, or check all three reports at www.annualcreditreport.com.
Of course, paying your bills on time, keeping your debt low, building a good track record, and keeping your credit accounts to a reasonable number are all time-honored methods for improving both your credit risk score and credit-based insurance scores. Keep these tips in mind for lower premiums and access to beneficial insurance policies.
As always, we are here to help you any way we can. Please don’t hesitate to call or email if you need us.
