How credit scores affect insurance rates
Your credit score
can have a profound effect on the amount you have to pay not only for auto insurance,
but for homeowners insurance also -- and perhaps on health and life insurance
in the not-too-distant future.
It's controversial, to be sure, but it's a fact. The question now is how does
it affect you?
Many insurance companies
and some academics feel strongly that a mediocre or bad credit rating means you're
a high risk. Many consumer advocates, state legislators, and state insurance regulators
think not. The debate may go on for quite awhile because even the true believers
admit they don't know why the two are related -- they just know they are.
And so, at least for now, it's a fait accompli.
Almost all auto insurers -- 92 of 100
polled in a recent survey by the research firm Conning & Co. -- and an increasing
number of companies writing homeowners insurance are now using credit information
to decide whether to issue a policy on your car and/or home. In some cases they
also use it to set the premium. They also use their own underwriting guidelines,
such as, in the case of homeowners insurance, the age of the house and the roof,
prior losses, and the home's construction type.
spokesmen at the trade associations for health and life underwriters say they
don't know of any of their members use credit scoring in underwriting and pricing
policies, but you may want to ask your health and life insurers if they do.
Bad credit, bad driver?
The Insurance Information Institute, a trade association for insurers,
says drivers at the bottom of the credit heap file 40 percent more claims than
drivers at the top of the pile. The institute doesn't have such statistics yet
for homeowners insurance claims.
"A consumer with bad credit is going to
pay 20 to 50 percent more in auto insurance premiums than a person who has good
credit," says Clarence Smith, former assistant vice-president at Conning
& Co. On the other hand, having sparkling credit could land you lower rates
so you should shop around if you've got a glowing report.
Elizabeth Mosley, of III, says, "Insurance
is based on risk, and research has shown that individuals who tend to not pay
their bills on time -- and then get low credit scores -- file more claims, and
that those claims are more expensive." When insurers get stuck with a bad
risk, she adds, other policyholders end up footing the bill.
But, she says, the news is not all bad.
"A lot of people benefit from it. Two-thirds
of policyholders have lower premiums because of their good credit record."
How they rate you
To factor in credit ratings, insurance companies use either the Fair, Isaacs
& Co. three-digit credit score alone; order an "insurance score"
from FICO; or create their own, proprietary score using FICO credit scores or
FICO insurance scores and adding in their own underwriting criteria.
The companies generally do not look at your
actual credit report. Instead, it receives your credit score or your insurance
score from one or more of the three major national credit repositories -- Equifax,
Experian and TransUnion. The two types of scores -- credit and insurance -- are
quite different. "An insurance score is going to be less concerned with
your propensity to take on new credit and more interested in how long you've
been managing credit," says Craig Watts, a FICO spokesman. "Insurance
scores focus on issues of stability."
Not everyone agrees.
The Boston Globe reports Massachusetts' Attorney
General Thomas F. Reilly and Boston's Mayor Thomas M. Menino have questioned
whether a customer's credit history is really a good indicator of his propensity
to file claims. They also charged that the use of credit information discriminates
against minorities and low-income people and unfairly penalizes those who have
gone through some life crisis like a job layoff or divorce."
The Conning & Co. study found most auto
insurance companies now do use credit data -- if allowed by their state
insurance regulator -- when underwriting new customers. Far fewer -- just
14 percent of the nation's largest insurers -- use credit data when you renew
your policy. Some states don't allow insurers to use credit scores at all in
insurance underwriting, and more seem to be moving in that direction.
Bad drivers better than credit risks
Insurers even claim the use of credit data in underwriting and renewing
an insurance policy can help drivers with dings on their driving record.
"Even with an accident, you could qualify
as a preferred customer with some insurance companies," says Conning &
Here's how: An auto insurer prices a policy
based on a customer's potential to file a future claim, not his potential to
damage his car or have his stereo stolen. The two are not necessarily the same.
Ironically, someone with a flawed driving record
but a clean credit record could pay less for auto insurance than someone with
a spotless driving record but a spotty credit record. Get it? That's how confident
the insurance industry is in the relationship between credit scores and insurance
A study by the Casualty Actuarial Society shows
that people with prior driving violations or accidents and good credit have
much better loss ratios than people with clean driving records and bad credit.
And a study by the University of Texas says there is a "significant relationship"
between credit scores and filed insurance claims.
An opposing view comes from Sara Lapham, who
which claims, "There has really been no independent study of the issue.
All the studies and the numbers come from insurers or the vendors of the scores.
Its hard to trust them because all of these companies have a vested interest
in seeing (insurance scoring) continue."
Bob Hunter, the former Insurance Commissioner
in Texas who is now director of insurance for the Consumer Federation of America,
criticizes the practice. "Even if there is correlation, the insurance companies
can't explain why that is. Just because you can correlate something doesn't
mean you should use that as the basis to set rates or determine if a policy
will be issued."
"I've asked them to explain to me why
credit relates to insurability, and they look at me like I've asked them to
explain Einstein's theory of relativity. Correlation is not enough. There needs
to be a logical basis for why my risk goes up. What do you tell the consumer,"
asks Hunter who says agents are having a hard time explaining the correlation
to their customers.
Many factors, of course, are considered when
insurers compute both auto and homeowner insurance rates. For autos, your age,
the type of car you drive, how many miles you drive and whether you live in
an urban or rural area are considered. For homeowners insurers, type of home,
location, how close it is to a fire station, and construction are just a few
of many factors. Just how big an impact your credit record has on your auto
and homeowners insurance bill varies, based on where you live and the insurance
company you choose as well as on what is in your credit report.
Obtaining your three-digit credit score is
easy nowadays. But good luck getting your insurance score. Insurance companies
aren't required to tell, and few do. "I don't know anybody who will show
you an insurance score," says Gerri Detweiler, author of The
Ultimate Credit Handbook. She adds, "It's still a bit of a mystery
Even if you could find out your insurance score,
it might not be all that helpful. Insurer-created insurance scores, unlike with
FICO credit scores, have no uniform standard and therefore nothing to compare
to. A different insurance company, using its own scoring model, could assign
you a different score and offer you vastly different rates.
It is important, however, to understand that
information in your credit report could affect the cost of your auto and homeowners
If you're having credit problems, it's best
to stick with your current insurer until your credit record improves. If you
must shop for a new policy, ask the insurer if it uses credit data in the decision-making
process. Not all insurance companies do. If you have good to excellent credit,
contact your agent to make sure you're getting the best rate possible or consider
getting bids from competitors who may appreciate more what a great non-risk
Christopher Cruise is a freelance writer based
-- Posted: Sept. 23, 2003