Anyone that's recently applied for a homeowners or car insurance policy may be familiar with insurance credit ratings. These ratings are based on the policyholder's credit score, and are oftentimes used by insurance companies to determine policy premiums. In this article, we're going to explain why insurance companies are now taking a closer look at an applicant's credit score. We're also going to explain how these companies can use the information found in a credit report to determine the premiums charged on a policy. Then we'll finish up by explaining what consumers can do to improve their scores.
Insurance Credit Scoring
Both federal and state law allow insurance companies to look at an applicant's credit information, without their knowledge, as provided under the rules of the Fair Credit Reporting Act. Because the law only allows credit reporting agencies to use certain information in calculating a consumer's rating, the industry has developed what is called an insurance credit score. Typical inputs to this score would include monthly bill payment patterns, the total number of credit cards and / or loans outstanding, collection activity, total outstanding debt, and the amount of history on an account.
How Insurance Credit Scoring is Used
Agencies use the above information to calculate a credit score, which is a numerical value that insurance companies then use to help them determine the monthly or annual premiums to charge a customer. They have started to do this because they believe there is a direct relationship between a consumer's payment history, or financial dependability, and insurance losses.
Insurance companies believe there is a direct relationship between a consumer's financial dependability, and insurance lossesMoneyzine Editor
For example, an individual or family that demonstrates less financial dependability may be more likely to file an insurance claim. For this reason, this individual or family should also pay higher premiums on their insurance policy. Under the law, insurance companies cannot increase an insurance premium if a policyholder does not have sufficient payment history to calculate a score. When a score can be calculated, insurance companies may use this information in the following ways:
Ratings: determines how large a premium is charged on an insurance policy. Negative factors in credit history can increase the cost of insurance.
Underwriting: this is the process of determining whether or not an insurance company will provide coverage to an individual, or renew an existing policy.
Calculating Insurance Credit Scores
Each agency will have a slightly different approach to calculating an insurance credit score; however, the elements that go into the score will be similar. Typically, these factors will include:
Bankruptcies, collection activity, home foreclosures, tax liens, and other information available through public records.
Frequency of late payments, late payment patterns to creditors and lenders.
Total number of lines of credit an individual has outstanding.
Credit in use, as well as credit history. In general, the more credit in use, and the more history on file, the better the rating.
Outstanding debt relative to the amount of credit being offered. Individuals that "max out" their credit are viewed as riskier individuals.
Good Scores
It's very difficult to answer the question: What is a good insurance credit score? Each insurance company is free to choose what they believe is, or is not, a good score. Different companies may view the same score in a slightly different way, or apply a slightly different policy premium.
Protections offered Consumers
Starting in January of 2003, consumers were offered some protections in terms of how insurance companies could use credit information. This includes data that cannot be used in a score's calculation, such as:
The total number of credit inquiries in a file.
The total amount of available credit that is not used.
An insufficient history to develop a score, or a lack of credit history.
Debt associated with the purchase of a new vehicle, or buying a new home.
The types or issuers of credit and debit cards carried.
This kind of information cannot be used to cancel, or non-renew, an existing insurance policy or deny coverage to a family or individual.
Insurance Premiums
Scores are just one of several factors used by companies to determine policy premiums. Insurance companies calculate their premiums based on factors such as the cost to replace a home or car, where the home is located, policy deductibles, and the breadth and depth of insurance provided by a policy. For example, if the policyholder elects to increase their liability insurance, that drives up the cost of the policy. If the policyholder elects to increase their plan deductibles, this will lower their cost.
Improving Scores
Let's finish this article by addressing one last question: How can I improve my insurance credit score? The most efficient way to improve a score is to find out what factors the insurance carrier uses to calculate their score. Most credit reporting agencies, such as Fair Isaac (which developed the FICO score), and Choice Point will provide insurance companies with up to four factors, each of which can have a positive or negative affect on a score. Consumers can ask their insurance agent, or call their insurance provider directly. They should be able to provide guidance on the exact factors used to calculate their score. Anyone that believes there are errors in their credit history file needs to repair this damage. In our article on the Fair Credit and Reporting Act, we outline the exact steps a consumer can take to get their credit report corrected.
Additional Resources
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