Alyssa Lane
Many insurance companies use consumer credit information to determine whether to offer insurance and how much to charge in premiums. This is known as a credit-based insurance score and is not the same as a regular credit score. Credit-based insurance scores are designed to predict the likelihood of an individual filing insurance claims that cost the company more than it collects in premiums. This can lead to higher premiums for those with poor credit. However, insurance credit checks are considered soft inquiries that do not affect credit scores.
| Characteristics | Values |
|---|---|
| How insurance companies use credit information | To determine eligibility and premium costs |
| Credit-based insurance scores | Introduced by FICO in the early 1990s |
| Factors considered by FICO | Payment history, outstanding debt, credit history length, pursuit of new credit, credit mix |
| Credit checks by insurance companies | Soft inquiries that don't affect credit scores |
| Credit-based insurance scores impact | Eligibility and premium costs |
| Other factors impacting insurance costs | Driving record, location, demographics, vehicle make and model, coverage types, insurance discounts |
| Consumer rights | Free credit report annually, right to know if denied coverage or charged more due to credit report |
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What You'll Learn
Credit-based insurance scores
In most states, insurers can use credit-based insurance scores as one factor in determining premiums for property insurance, such as auto and homeowners' insurance. Some states, like California, Hawaii, Maryland, Michigan, and Massachusetts, ban or limit the use of credit scores in setting policy rates.
FICO considers five general areas to determine an individual's credit-based insurance score:
- Payment history (40%): How well an individual has made payments on their outstanding debt in the past.
- Outstanding debt (30%): The amount of debt an individual currently has.
- Credit history length (15%): How long an individual has had a line of credit.
- Pursuit of new credit (10%): Whether an individual has applied for new lines of credit recently.
- Credit mix (5%): The types of credit an individual has, such as credit cards, mortgages, or auto loans.
It is important to note that a credit-based insurance score is not the same as a regular credit score. Individuals can obtain a free credit report annually from Equifax, Experian, and TransUnion to check for errors and understand their credit-based insurance score.
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How insurance companies use credit scores
Insurance companies often use consumer credit information to determine whether they will offer a consumer automobile or homeowners' insurance policy and how much that policy will cost. A credit-based insurance score is a rating based on a consumer's credit information. Credit-based insurance scores were introduced by the Fair Isaac Corporation (FICO) in the early 1990s. FICO estimates that approximately 95% of auto insurers and 85% of homeowners' insurers use credit-based insurance scores in states where it is legally allowed.
In most states, insurers can use credit-based insurance scores to determine premiums. Credit-based insurance scores are not the same as regular credit scores. According to FICO, a data and analytics company that measures credit risks, insurers use credit-based insurance scores in states where it is legally allowed. An insurance company can only use a credit-based insurance score as one factor in its underwriting process. It will be considered with several other factors that vary by insurance type. For example, with auto insurance, other factors could be the age of the operators, the make, model, and age of the car, and the miles driven annually.
FICO looks at five general areas that it believes will best determine how individuals manage risk. The five areas are payment history (40%), outstanding debt (30%), credit history length (15%), pursuit of new credit (10%), and credit mix (5%). Information that is not in an individual's credit report and cannot be used includes certain types of inquiries on the credit report, such as account review inquiries, employment inquiries, and promotional inquiries from credit companies.
The Fair and Accurate Credit Transaction Act of 2003 (FACT Act) allows consumers to obtain a free credit report once every 12 months from each of the three nationwide consumer credit reporting companies (Equifax, Experian, and TransUnion). Consumers can go to annualcreditreport.com to check all three reports annually without paying a fee or being asked to buy other products. If individuals find errors on their credit report, they should contact the credit reporting company to have them corrected, as errors could affect their credit-based insurance score.
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Soft vs hard credit pulls
Soft and hard credit pulls are two different types of credit inquiries that provide a glimpse into your credit history. While both types of credit checks are listed on your credit report, only hard inquiries affect your credit score.
A soft credit pull, also known as a soft credit inquiry or soft credit check, occurs when a person or company checks your credit as part of a background check. Soft pulls are typically used for promotional purposes or as part of a screening process. For example, a soft pull may occur when a credit card issuer checks your credit to see if you qualify for certain credit card offers, or when an employer runs a background check before hiring you. Soft pulls can also occur when you check your own credit score or when you receive a pre-qualified insurance offer. Soft pulls do not require your permission, and they will not lower your credit score.
A hard credit pull, on the other hand, occurs when you apply for a loan, credit card, or new credit. A hard pull involves a creditor accessing your credit file to assess your creditworthiness and determine whether to approve you for a line of credit. Hard pulls typically occur when you apply for a mortgage, loan, or credit card, and they usually require your authorization. While a single hard inquiry may lower your credit score by a few points, it typically has a negligible effect. However, multiple hard inquiries in a short period of time can have a compounding negative effect, as lenders may view this as a sign of increased risk.
It is important to note that soft and hard credit pulls provide similar information. The main difference lies in the purpose and impact on your credit score. Soft pulls are used for preliminary screenings or promotional purposes, while hard pulls are used when a lender needs a complete examination of your credit history to make a lending decision.
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Credit report errors
Credit reports are used by insurance companies to determine if they will offer a consumer automobile or homeowners' insurance policy and how much that policy will cost. A credit-based insurance score is a rating based on a consumer's credit information. Therefore, it is important to have an accurate credit report.
To dispute credit report errors, you should contact both the credit bureau and the business that supplied the information. You have the right to dispute errors and request corrections, and both parties are obliged to correct any inaccurate or incomplete information for free. You can use a sample letter to dispute mistakes with businesses, including your complete name and address, the inaccurate information, and supporting documents.
Additionally, you can ask the credit bureau to provide your statement to anyone who received your credit report recently, although they may charge a fee for this service. It is important to regularly check your credit report for accuracy and dispute any errors promptly. You are entitled to receive free copies of your credit report from each of the three major credit bureaus once every 12 months.
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Credit history and insurance
Credit-based insurance scores are used by insurance companies to determine eligibility and premiums for insurance policies. These scores are based on credit history and other factors, such as payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix. While insurance companies can use these scores to make decisions about coverage and rates, they cannot solely rely on them to deny coverage or cancel policies.
In most states, insurance companies can use credit-based insurance scores as a factor in their decisions. However, some states have restrictions or bans on the use of credit history in certain situations. For example, in Maryland, insurance companies can only consider credit when initially setting rates, while in Michigan, credit can only be a factor when deciding on an installment payment plan.
Credit-based insurance scores are not the same as traditional credit scores. These scores are designed to predict the likelihood of an insurance loss and are used in conjunction with other factors, such as ZIP code, operator age, vehicle details, and annual mileage, to determine insurance premiums. While these scores can impact insurance rates, they do not affect everyone equally, and other factors may be more influential in certain cases.
It is important to note that insurance companies are required to disclose their use of credit information and provide written explanations if an individual does not receive the best rate due to their credit history. Individuals also have the right to request a free copy of their credit report annually and correct any errors that may impact their insurance scores. Additionally, insurers may reconsider premium changes if a policyholder experiences extraordinary life circumstances, such as a catastrophic event, job loss, or serious illness.
While the use of credit-based insurance scores is prevalent in the industry, it has sparked debates about its fairness and potential financial burden on individuals with negative marks on their credit history, including those who have been victims of identity theft or experienced unforeseen life events.
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Frequently asked questions
Insurance companies use credit-based insurance scores to determine eligibility and how much to charge in premiums. Credit-based insurance scores are designed to predict the likelihood of filing insurance claims that cost the company more than it collects in premiums.
A hard pull or hard inquiry is a record of a credit check for lending purposes, which may hurt your credit score. A soft pull or soft inquiry is a credit check that does not show up and does not impact your score. Insurance companies perform soft pulls.
It is recommended to check your credit report regularly for any changes or errors. You can obtain a free credit report once every 12 months from each of the three major consumer credit reporting companies (Equifax, Experian and TransUnion). It is also important to make payments on time and keep credit card balances as low as possible.
