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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.

So far, 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.

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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 & Co.'s Smith.

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 risk.

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 heads www.insurancescored.com, 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 to consumers."

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 insurance.

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 you are.

Christopher Cruise is a freelance writer based in Maryland.

-- Posted: Sept. 23, 2003

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