Bad Credit, High Insurance Rates
How Credit-based Scoring Works, Where it’s Used, Why it’s Important
Insurers use applicants' credit data to "score" risks and set premiums. Scores can vary widely among carriers for identical coverage, and premiums can differ 50% or more.
Most car and home insurers use proprietary credit-based scoring systems to decide whether to issue or renew a policy, and how much to charge. Insurance scores significantly affect premiums.
Mysterious and controversial, these systems have been in use since 1993, and supposedly predict whether an insured party will file claims, and their anticipated cost. Insurers believe they have statistical proof that individuals with poor insurance scores are also poor risks, and should pay higher premiums.
How Insurance Premiums Are Calculated
Several factors affect insurance rates besides one's credit-based risk score. For example, auto premiums typically (but not universally) depend upon:
- Accident, claims and violation history
- Age, sex, marital and employment or student status
- Years driving and continuous insurance coverage
- Vehicle age, make and model and the Zip code where it is garaged
- Driver commuting distance and miles driven annually, and how the vehicle is used
- Coverage options and deductibles
Property hazard insurance rates commonly are based on:
- Zip code, age, size, construction type and condition of the premises
- Property improvements, updates, features and amenities
- Distance from a fire department and hydrant
- Claims and loss history
- Coverage options and deductibles
Insurance Score vs. Credit Score
Credit-based insurance scoring is different from and more arbitrary and complex than the more uniform credit reports used by banks and credit card issuers. Insurers use secret proprietary systems--often developed by Ph.D.-level mathematicians--and few reveal details about how they compute scores, nor do they disclose exactly what role they play in setting premiums. Consequently, it is impossible for an individual to know their score—and thus their rate—until they apply for coverage.
Before credit-based scoring took off, there were relatively few rating "tiers." Now, using credit-based scoring, insurers have hundreds of premium tiers.
Insurers contend that were they to abandon their proven systems, premiums would rise for 60 to 70 percent of their customers. According to the Insurance Information Insitute, "...actuarial studies show that how a person manages his or her financial affairs, which is what an insurance score indicates, is a good predictor of insurance claims." Exactly what "financial affairs" do insurers measure?
Credit Factors that Influence Insurance Scoring
- Financial difficulties, such as delinquencies, defaults and bankruptcy, are harmful.
- A history of on-time loan and credit card payments improves scores.
- Low ratios of loan balances to credit limits are beneficial.
- For some insurers, the longer one's first credit account has been open, the better. Others examine the average age of accounts.
- Recent loan shopping, and the number of inquiries made without accepting the credit, can lower a score.
- The number and types of loans and credit cards one has can be important. Major bank cards (VISA/MasterCard/Amex/Discover) apparently are treated more favorably than department store cards and finance-company credit.
- The number of credit accounts opened within the previous year and/or recent months can influence scores.
How Scores Are Calculated
Insurance scoring models were created and sold by ChoicePoint and Fair Isaac Corppration (FICO), two large credit-gathering organizations. Some insurers developed their own systems. The models emphasize and analyze bits of credit data that to the average person would seem to have little to do with a driver’s likelihood of filing claims. There are no standards: each company uses different sophisticated modeling and actuarial techniques and weighs different credit-report data using complex formulas. According to the Federal Trade Commission, all states except Vermont and Pennsylvania in some way regulate the use of consumer credit information in insurance underwriting and rating.
What Insurance Customers Need to Know
Under the Fair Credit Reporting Act, insurance agents must ask permission of applicants before using credit information in quoting premiums. Expect higher premiums or denial of coverage when refusing to authorize a credit inquiry.
A poor credit-based score usually is associated with a poor “ordinary” credit rating. For example, an individual with delinquencies or a substandard bill-paying history may pay up to twice as much for auto or homeowners coverage, than if the score were excellent. Since scores are not easily available, and every insurer calculates them differently, it pays to shop and compare rates.
Further Information
Insurance Information Institute
National Association of Mutual Insurance Companies (NAMIC)
