Jeffrey Wade
Credit scores are used by insurance companies to determine whether to offer a consumer an insurance policy and how much that policy will cost. Credit-based insurance scores are used to predict the risk of loss and are not the same as a regular credit score. While insurance quotes do not affect credit scores, credit card companies running your credit score can negatively affect it. Credit scoring in insurance has been deemed an unfair practice as it penalizes low-income and minority communities.
| Characteristics | Values |
|---|---|
| Credit-based insurance scores | Not the same as a credit score |
| Credit-based insurance scores usage | Used by insurers to determine premiums |
| Credit-based insurance scores usage | Used by insurers for underwriting |
| Credit-based insurance scores usage | Used to assign consumers to a pool based on risk |
| Credit-based insurance scores usage | Used to adjust the premium up or down |
| Credit-based insurance scores usage | Used by insurers to determine if they will offer a consumer automobile or homeowners' insurance policy |
| Credit-based insurance scores usage | Used by insurers to determine how much a policy will cost |
| Credit-based insurance scores | Introduced by the Fair Isaac Corporation (FICO) in the early 1990s |
| Credit-based insurance scores | Used primarily in underwriting and rating of consumers |
| Credit-based insurance scores | FICO estimates approximately 95% of auto insurers and 85% of homeowners' insurers use them |
| Credit-based insurance scores | Used in states where it is legally allowed |
| Credit-based insurance scores | Considered with several other factors that vary by insurance type |
| Credit-based insurance scores | Can be requested by the consumer from the insurer |
| Credit-based insurance scores | Errors in credit reports can hurt insurance credit scores |
| Credit-based insurance scores | Credit information cannot be used by insurers to deny coverage or cancel a policy |
| Credit-based insurance scores | Insurers must check credit history every three years |
| Credit-based insurance scores | Insurers can use credit information when deciding what to charge for insurance premiums |
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What You'll Learn
- Credit-based insurance scores are not the same as credit scores
- Insurers use credit-based insurance scores to predict the risk of loss
- Credit history affects insurance premiums
- Credit report errors can hurt your insurance credit score
- Insurance credit scoring can be biased against low-income and minority consumers
Credit-based insurance scores are not the same as credit scores
Credit-based insurance scores are designed to predict the risk of loss. Insurers use these scores for underwriting to assign consumers to a pool based on risk and then for rating by deciding how to adjust the premium up or down. FICO looks at five general areas that it believes will best determine how you manage risk. These are:
- Payment history (40%) — How well you have made payments on your outstanding debt in the past.
- Outstanding debt (30%) — How much debt you currently have.
- Credit history length (15%) — How long you have had a line of credit.
- Pursuit of new credit (10%) — If you have applied for new lines of credit recently.
- Credit mix (5%) — The types of credit you have (credit card, mortgage, auto loans, etc.).
A credit-based insurance score cannot use any personal information to determine your score. Certain types of inquiries on your credit report, such as account review inquiries, employment inquiries, and promotional inquiries from credit companies, will not affect your credit-based insurance score. However, it is important to note that insurance companies often use consumer credit information to determine whether to offer a consumer automobile or homeowners' insurance policy and how much that policy will cost.
Errors on your credit report could affect your credit-based insurance score. It is recommended to check your credit report regularly and contact the credit reporting company to correct any errors. Additionally, while credit card companies' inquiries may negatively affect your credit score, insurance companies' inquiries are considered a "soft hit" and do not impact your score.
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Insurers use credit-based insurance scores to predict the risk of loss
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 permitted. According to FICO, insurers can only use credit-based insurance scores as one factor in their underwriting process, alongside other factors that vary by insurance type. For example, with auto insurance, other factors include the zip code, the age of the operators, the make and model of the car, and the annual mileage.
FICO considers five main areas when determining an individual's credit-based insurance score: payment history (40%), outstanding debt (30%), credit history length (15%), pursuit of new credit (10%), and credit mix (5%). Credit-based insurance scoring is controversial, with consumer groups expressing concerns about a lack of transparency and potential negative impacts on minority and low-income communities.
An individual's credit score can significantly impact their insurance rates. Generally, a good credit score is 670 or above, with scores above 800 considered excellent. Individuals with excellent credit scores are likely to receive lower insurance rates. Conversely, those with poor credit scores may pay substantially more for insurance coverage. For example, in the case of auto insurance, a poor credit score could increase the cost of coverage by up to 106%.
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Credit history affects insurance premiums
Credit scores and insurance are interconnected. Credit-based insurance scores are not the same as regular credit scores. Credit-based insurance scores are used by insurers to predict the risk of loss and adjust the premium accordingly. Insurers use these scores to differentiate potential insurance risks and charge a premium based on the risk they are assuming. Statistics show that people with poor insurance scores are more likely to file a claim.
An insurance score is an insurer-generated numerical ranking based on a person's credit history. The credit-based information that goes into an insurance score includes payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix. While insurance companies cannot use credit history alone to deny coverage or cancel a policy, they can use it to set premiums. State and federal laws allow insurance companies to consider credit history when deciding on insurance rates.
Credit history can impact insurance premiums for auto and homeowner insurance policies. Insurance companies use credit information to determine eligibility, the specific policies offered, and the cost of the policy. They consider factors such as bankruptcy, collections, foreclosures, and liens, which can lower insurance credit scores. Additionally, the absence of credit history or information can negatively impact insurance scores.
Establishing and maintaining a solid credit history can help reduce insurance costs. Individuals can achieve this by paying bills on time, managing credit card balances, and obtaining only the necessary credit. Regularly reviewing credit reports from different credit bureaus is essential to identify and correct any errors that may impact insurance premiums. Individuals can obtain free credit reports annually from major credit bureaus and request exceptions from insurance companies if their credit was affected by protected events.
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Credit report errors can hurt your insurance credit score
While insurance inquiries do not affect your credit score, credit report errors can hurt your insurance credit score. Credit-based insurance scores are used by insurers to determine your premiums and whether to offer you an insurance policy. These scores are based on certain elements of your credit history, such as how many times your credit report has been checked, what type of credit you have, your credit balance, and how long you have used credit.
Incorrect information on your credit report, such as missed payments or bankruptcy, can lower your insurance score and raise your premium. Credit report errors are common and can be challenging to correct. It is important to regularly check your credit report from the credit bureau used by your insurance company, as the information can vary across different credit bureaus. If you identify any mistakes, you should dispute them with the credit bureau by providing supporting documents and requesting the removal or correction of inaccurate information.
In addition to incorrect information, missing information on your credit report can also hurt your insurance score. This can occur when you have a limited credit history or if there are gaps in your credit information. For example, if you have a low number of credit cards or a short credit history, your score may be lower compared to someone with a longer credit history and more credit cards.
Furthermore, insurance credit scoring has been criticized for penalizing low-income and minority communities. The absence of credit information or a limited credit history, which is more common among these groups, can negatively impact their insurance scores. This perpetuates historical inequities and makes it more difficult for these communities to obtain affordable insurance policies.
To maintain a healthy insurance credit score, it is crucial to periodically review your credit report, dispute any inaccuracies, and address any missing information. By proactively managing your credit history and understanding how it affects your insurance score, you can ensure that your insurance credit score accurately represents your creditworthiness and helps you obtain favorable insurance terms.
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Insurance credit scoring can be biased against low-income and minority consumers
Insurance companies have been using credit-based insurance scores for the past 20 years to determine whether to offer a consumer automobile or homeowners' insurance and how much to charge. Insurers claim that this practice helps predict the risk of loss. However, critics argue that insurance credit scoring models are biased against low-income and minority consumers. This bias is not because these consumers are poor money managers but because negative factors in the models disadvantage them. Additionally, the absence of credit information can hurt their scores more than the presence of negative information.
The use of credit-based insurance scores can result in significant disparities in premiums. A consumer with the worst credit score may pay up to four times as much as a consumer with the best credit score, even if all other factors are equal. This practice disproportionately affects low-income and minority consumers, who are often the target of predatory lending practices. As a result, insurance credit scoring reflects and perpetuates historical inequities.
The bias in insurance credit scoring is part of a broader issue of bias in credit scoring systems. Studies have found that credit scores are less accurate for low-income and minority borrowers, with predictive tools being 5 to 10% less accurate for these groups. This inaccuracy is due to biased data and algorithms that skew automated decision-making against these communities. For example, software used by banks to predict credit-card debt repayment often favors wealthier white applicants.
The impact of biased credit scoring goes beyond insurance. Credit scores are now used for life-changing decisions, including hiring, loan approvals, and housing. The result is a misallocation of credit, with people from disadvantaged communities being turned down more often than they should be. This perpetuates inequalities as these individuals have fewer opportunities to build solid credit records.
To address these issues, consumers should be proactive in understanding their insurance credit scores and how they affect their premiums. They can request information from insurers about the insurance credit score used and how it impacted their premium. Additionally, consumers should regularly review their credit reports for errors and missing information, as these can negatively affect their scores.
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Frequently asked questions
Insurance inquiries do not affect your credit score. However, insurance companies often use consumer credit information to determine if they will offer a consumer an 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 use certain elements of a person's credit history to predict how likely they are to have an insurance loss.
You can ask your insurance company if they use credit-based insurance scores to underwrite and rate your policy and which risk category you were placed in.
