Have you heard that your credit score can affect how much you pay for insurance?
As a consumer, you probably know everyone has a financial credit score — three of them, in fact — 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 used to predict how much debt you can take on and repay. These scores are often referred to as FICO® scores, a term derived from the name of the leading company in the development of credit scoring, Fair Isaac Corp.
The higher your financial credit score, the more debt you can take on and obtain relatively favorable rates. The lower your score, the more limited you will be in the amount you can borrow. Your interest rate and loan terms will be likely be less favorable.
In the 1990s, working with Fair Isaac, major insurance companies began incorporating credit history and credit scores into “credit-based insurance scores” used 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 possibility you will default. Despite their similarities, there are some important differences between credit-scores and credit-based insurance scores:
- While credit scores are an overriding, almost exclusive, factor in loan underwriting, credit-based insurance scores are used as 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 insurance scores for individuals is not as easy. For the most part, credit-based insurance scores are developed and utilized differently by insurers. Talk to your insurance agent about getting a copy of your insurance score.
Consumer advocates argued that credit history should not be used as a measure of how someone drives or manages a household. There are police and insurance records that provide direct indications of that behavior.
In addition, since credit scores take income into account, critics of credit-based insurance scores argue 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 enacted laws or regulations prohibiting the use of one’s credit record as the sole criterion for taking any “adverse action” against an applicant or insured (an adverse action being a rejection of coverage, an additional charge or premium spike).
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 confirming a strong correlation between a person’s credit history and their likelihood of making an insurance claim.
What do you do?
Now that credit-based insurance scores are a part of auto and homeowners underwriting and pricing, what should you do?
The answer is simple: Do what you should be doing anyway with your credit and insurance profile. Don’t overextend yourself financially, drive carefully, remove hazards from your yard, reduce clutter in your living space and do what you can to prepare your home for storms.
Sometimes 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 have to park your car outside on a busy street, you may live in an area prone to theft and vandalism or you may not be able to afford the improvements your home may need.
Nonetheless, your best approach to the most favorable situation you can achieve — in terms of both credit and insurance — is to look beyond the scores to the factors that determine them.
As always, contact your insurance professional if you have any questions regarding your credit score and how it can affect your premiums.