How Does Credit Affect Insurance?
How Do Insurance Companies Use Credit?
Many insurers now use a tool called an insurance score or a credit-based insurance score along with motor vehicle records, loss reports and application information when determining eligibility and premiums. This score is based on information from consumers’ credit history.
Why Do Insurers Use Credit History?
A system using credit information to estimate the amount of money a company would likely pay in claims for a customer was developed in the mid-1990s. Use of this system increased rapidly, primarily because insurers found it was an effective predictor of risk. Initially, it enabled companies to provide less-expensive coverage to those customers who had good credit ratings. This gave the companies using the credit-based system a competitive edge in relation to their competitors and helped spread its use.
Which Insurers Use Credit History?
At this time the score is used widely within the homeowner and auto insurance industries. Most medical insurance companies do not use the score to calculate rates, but may begin incorporating credit information in some capacity in the near future.
What Is a Credit-Based Insurance Score?
How Is a Credit-Based Insurance Score Generated?
Insurance scores draw on information from credit history to calculate a numeric score. Insurers can obtain insurance scores from FICO or a credit bureau, but many of them have developed their own models for scoring.
What Credit Information Affects an Insurance Score?
Insurers utilize information from credit history that they believe best helps them predict insurance risk. Typically, insurers base scores on:
- information about past delinquencies or bankruptcies,
- debt ratios (how close a consumer is to his or her credit limit)
- evidence of seeking new credit
- the length and age of credit history
- the use of certain types of credit (for example, auto loans)
Many companies also factor in a person’s claims history and public record information, such as accident reports (for auto insurance). They may pull income and asset information from the submitted application to include in their proprietary score as well.
Is Use of a Credit-Based Insurance Score Fair to Consumers?
Are Insurance Scores Regulated?
Insurance companies are granted the right to use credit information to evaluate applications. This right, known as permissible purpose, is summarized in Section 604 of the Fair Credit Reporting Act (pdf).
The use of an insurance score is regulated by state law. Some states require mandatory disclosure of how an insurer’s score is calculated and applied. Some states ban the use of scores within specific insurance industries.
Will Insurers Continue to Use Credit-Based Scores?
Yes, almost certainly. The insurance industries have widely supported the use of insurance scoring. The majority of auto and homeowner insurers are using credit information and/or an insurance score in some capacity. It is estimated that the use of credit will only become more prevalent in these industries (and potentially other insurance industries) in the upcoming years.
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