Paul Sanchez
Credit-based insurance scores are used by insurance companies to determine if they will offer a consumer an insurance policy, which policy they will offer, and how much that policy will cost. These scores are based on a consumer's credit information, including their payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix. While insurance companies argue that credit-based insurance scores are necessary to evaluate risk and charge policyholders rates that align with their risk, consumer groups have concerns about the use of these scores, including the fact that most consumers do not understand how they work. Additionally, critics argue that credit-based insurance scoring unfairly penalizes consumers who are victims of medical or economic catastrophes. While not all states allow the use of credit-based insurance scores in determining premiums, in most states, insurers can use these scores as one factor in their decision-making process.
| Characteristics | Values |
|---|---|
| Use of credit-based insurance scores | Decreased premiums on 57.4% of auto policies, increased premiums on 23.4% and no effect on the remaining 19.2% of policies |
| States where credit-based insurance scores are restricted or banned | California, Hawaii, Maryland, Michigan, Massachusetts, Oregon, Utah |
| Factors that determine credit-based insurance scores | Payment history (40%), outstanding debt (30%), credit history length (15%), pursuit of new credit (10%) |
| Impact of incorrect information on credit report | Lower insurance score and higher premium |
| Impact of missing information on credit report | Lower insurance score |
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What You'll Learn
- Credit-based insurance scores are used to determine insurance premiums
- Credit history is used to decide eligibility for insurance
- Credit-based insurance scores are banned or restricted in some states
- Insurers claim credit-based insurance scores are necessary to evaluate risk
- Credit-based insurance scores are considered unfair by consumer advocates
Credit-based insurance scores are used to determine insurance premiums
Credit-based insurance scores are used by insurance companies to determine insurance premiums. Insurers argue that using these scores helps them properly evaluate risk and charge policyholders rates that align with their risk level. In this way, they can ensure that lower-risk individuals are not subsidising higher-risk individuals.
Credit-based insurance scores are not the same as a regular credit score. They are based on certain elements of a person's credit history, such as payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix. These scores do not use any personal information or certain types of inquiries on a credit report, such as account reviews or promotional inquiries from credit companies.
In the United States, the use of credit-based insurance scores to determine premiums is not allowed in all states. Some states only permit it as a factor for property insurance, such as auto and homeowners insurance, while others allow it for any type of insurance. States like California, Hawaii, Maryland, Michigan, and Massachusetts have banned or limited the use of credit scores in setting policy rates.
The impact of credit-based insurance scores on premiums can be significant. A study by the Arkansas Insurance Department in 2017 found that these scores decreased premiums for 57.4% of auto policies and increased premiums for 23.4%. In some cases, consumers with poor credit scores may end up paying two to four times more for insurance than those with excellent credit scores.
While insurers defend the practice as rewarding responsible consumers, critics argue that it is unfair, particularly for individuals facing medical or economic hardships. Additionally, consumer groups express concern over the lack of transparency and understanding among consumers regarding the use of credit-based insurance scoring.
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Credit history is used to decide eligibility for insurance
Credit history is a significant factor in determining eligibility for insurance. Insurance companies use credit-based insurance scoring to assess an individual's creditworthiness and decide whether to offer them a policy. This practice has been standard for the past two decades, with insurers arguing that credit history can predict the likelihood of filing insurance claims.
While the specific weight of credit history in insurance decisions varies, it often carries more weight than other factors such as driving records or the condition of one's home. A person with a poor credit score may end up paying significantly higher premiums than someone with an excellent credit score, even when all other factors are equal. This can particularly disadvantage low-income and minority communities, perpetuating historical inequities.
In most states, insurance companies have considerable leeway in using credit information. They can deny coverage or charge higher premiums based on credit history, though they must provide written explanations for adverse actions resulting from credit information. Some states, like California, Massachusetts, Hawaii, Maryland, and Oregon, restrict or ban the use of credit history in certain insurance contexts.
Credit-based insurance scores are calculated using various factors, including payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix. These scores are not the same as an individual's credit score, and insurance companies cannot use credit history alone to deny coverage or cancel a policy. Instead, they use it in conjunction with other factors to determine eligibility and set premium rates.
Individuals can request their credit-based insurance scores and review their credit reports to understand how insurers may perceive them. While getting insurance quotes may not affect these scores, individuals can regularly seek quotes to find more affordable insurance options.
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Credit-based insurance scores are banned or restricted in some states
In 2017, the Arkansas Insurance Department studied the impact of credit-based insurance scores on premiums. They found that these scores decreased premiums on 57.4% of auto policies, increased premiums on 23.4%, and had no effect on the remaining 19.2% of policies.
Some states have placed restrictions on the use of credit-based insurance scores. In Maryland, insurance companies can only consider credit when initially setting rates. Michigan restricts the use of credit-based insurance scores to deciding whether to offer an instalment payment plan. Oregon only allows credit to be considered when setting initial rates. Utah permits credit information to be used when initially underwriting an auto policy, but it cannot be the only factor in the decision. Additionally, once a customer has been with the company for 60 days, credit information cannot be used to cancel or refuse to renew a policy.
A few states have implemented outright bans on the use of credit-based insurance scores. California banned the practice in 2003, prohibiting insurance companies from using credit scores or history when approving or determining rates on auto or home insurance policies. Hawaii has a similar ban for auto insurance, while Massachusetts bans the use of credit scoring for both auto and homeowner insurance. Washington has also temporarily banned the use of credit scores for auto, renter, and homeowner insurance due to concerns about the impact of the COVID-19 pandemic on people's financial situations and credit scores.
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Insurers claim credit-based insurance scores are necessary to evaluate risk
Insurers claim that credit-based insurance scores are an essential tool for evaluating risk and setting premiums. The scores are numerical values that predict the likelihood of a consumer experiencing an insurance loss and filing a claim. By assessing an individual's credit history, insurers can determine their insurance risk category and adjust premiums accordingly.
The use of credit-based insurance scores has been a topic of debate, with consumer groups expressing concerns about the lack of understanding among consumers regarding this scoring system. Some critics also argue that the system disproportionately affects certain minority and low-income groups. However, insurers defend their use of credit-based insurance scores, stating that they help ensure that lower-risk individuals do not bear the costs of higher-risk individuals.
In 2017, the Arkansas Insurance Department conducted a study on the impact of credit-based insurance scores on premiums. The results showed that while scores decreased premiums for 57.4% of auto policies, they increased premiums for 23.4%. The remaining 19.2% of policies were unaffected. This study highlights the potential financial implications of using credit-based insurance scores.
While the use of credit-based insurance scores is permitted in some states, others have placed restrictions or bans on this practice for auto and homeowners' insurance policies. For example, in Maryland, insurers can only consider credit when initially setting rates, while in Michigan, credit history is only relevant when deciding on an instalment payment plan. These varying state regulations underscore the importance of consumers understanding their rights and the factors influencing their insurance premiums.
Ultimately, insurers maintain that credit-based insurance scores are a critical component of their risk evaluation process, allowing them to set premiums that align with an individual's risk profile. However, consumers should be aware of their state's laws regarding the use of credit history in insurance and actively monitor their credit reports to ensure accuracy and protect their financial interests.
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Credit-based insurance scores are considered unfair by consumer advocates
Secondly, insurance credit scoring can penalise consumers for rational behaviour. For example, when shopping around for insurance, multiple companies checking a consumer's credit can increase the number of inquiries on their credit report, negatively impacting their score. Similarly, using one credit card for rewards or opening a new card account for a discount can result in a worse credit score due to the additional inquiry and higher debt-to-card limit ratio.
Thirdly, insurance credit scoring has been criticised for disproportionately impacting low-income and minority communities. The negative factors used in the scoring models may be biased against these communities, and the absence of credit information can also hurt their scores.
Furthermore, consumer advocates argue that insurance companies should not rely solely on credit history to determine insurance rates. While credit-based insurance scores are designed to predict the likelihood of filing costly claims, other factors such as driving record or home condition may be more relevant and should be given greater consideration.
In response to these concerns, some states in the US have implemented restrictions or bans on the use of credit history or credit-based insurance scores by insurance companies. These include California, Hawaii, Maryland, Massachusetts, Michigan, Oregon, and Utah, which have strict limitations for auto or homeowners insurance policies.
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Frequently asked questions
A credit-based insurance score is a rating based in whole or in part on a consumer's credit information. It was introduced by the Fair Isaac Corporation (FICO) in the early 1990s.
Insurance companies use credit-based insurance scores to determine if they will offer a consumer an insurance policy, which policies they will make available, and how much they will charge.
Five different factors are used to determine a credit-based insurance score: payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix.
No, not all states allow the use of credit-based insurance scores in determining premiums. Some states only allow it as one factor for property insurance like auto and homeowners insurance. Other states, such as California, Hawaii, Maryland, Michigan, and Massachusetts, ban or limit its use.
You can ask your insurance company if a credit-based insurance score was used to underwrite and rate your policy and about the risk category you were assigned. You can also obtain a free credit report once a year from each of the three nationwide consumer credit reporting companies (Equifax, Experian, and TransUnion).
