Have you heard that your credit score can affect how much you pay for insurance?
As a consumer, you probably know everyone has a credit score maintained by three major credit reporting agencies: Equifax, Experian and TransUnion. These firms compile information from financial institutions and retailers, including how much you earn, your current debt and your payment history.
A numerical score is calculated from this information, which is then used to predict how much debt you can take on and repay. These scores are often referred to as FICO® scores. The term FICO comes from the company that developed credit scoring, the Fair Isaac Corporatation.
The higher your credit score, the more debt you can take on and the more favorable your rates will be. The lower your score, the more limited your borrowing will be. Your interest rate and loan terms will likely be less favorable as well.
Insurance applications
In the 1990s, major insurance companies working with the Fair Isaac Corporation began to incorporate credit history and credit scores into “credit-based insurance scores.” They used the information to underwrite and price auto and homeowners insurance.
A credit-based insurance score helps predict the probability that you will file an insurance claim, much as a credit score predicts the probability that you will default. Despite their similarities, there are some important differences between credit scores and credit-based insurance scores:
- Credit scores are an overriding, almost exclusive, factor in loan underwriting. Credit-based insurance scores are one factor among many in insurance underwriting.
- Credit decisions normally consider your income. Insurers are generally prohibited from considering an applicant’s income.
- You can ask for your financial credit scores from the reporting agencies, but obtaining your credit-based insurance score is not as easy. For the most part, insurers use credit-based insurance scores differently. Talk to us about getting a copy of your insurance score.
Restrictions
Consumer advocates have argued that credit history should not be used as a measure of how someone drives or manages their household. Police and insurance records provide direct indications of that behavior.
In addition, since credit scores consider income, critics of credit-based insurance scores argue that they contribute to unfair discrimination against lower-income people. In their estimation, a low-income person with a good driving record but a low credit score could be unfairly disadvantaged.
In response, many states have enacted laws or regulations prohibiting insurance companies from using a person's credit record as the sole factor in taking “adverse action” against them. Adverse actions apply to applicants and insureds. Examples include denying coverage and raising premiums.
Credit considerations have not been entirely eliminated from insurance. However, credit-based insurance scores are still widely used. Key to their acceptance were several studies in the mid-2000s correlating a person’s credit history with their likelihood of making an insurance claim.
What can you do?
Knowing that credit-based insurance scores are a part of auto and homeowners underwriting and pricing, what can you do?
The answer is simple: Do what you should be doing anyway with your credit and insurance profile. For example:
- Don’t overextend yourself financially.
- Drive defensively.
- Remove hazards from your yard.
- Reduce clutter in your living space.
- Prepare your home for severe weather.
You can’t avoid certain risks, no matter how careful you are. You may not be able to afford a vehicle with the latest safety features. You may live in an area prone to theft and vandalism. Or you may not be able to afford home improvements.
Still, your best approach is to look beyond your credit score to the factors that determine it.
As always, contact us if you have any questions about your credit score and how it affects your premiums.