Jane Dotson
An insurance score is a rating used by insurance companies to determine the probability of a client filing an insurance claim. It is a numerical point system based on select credit report characteristics. While there is no direct relationship with financial credit scores, insurance scores are calculated using much of the same information as credit scores, including financial habits and choices. The scores are used to determine the total premium an individual pays for health, homeowners, auto, and life insurance policies. A low insurance score can be costly, especially for auto insurance coverage, which is legally required for car drivers in 49 of the 50 states in America.
| Characteristics | Values |
|---|---|
| Purpose | To predict the risk of a client filing an insurance claim |
| Basis | Credit report information and other factors like driving experience, previous claims, vehicle age, financial habits, etc. |
| Impact | Determines the total premium an individual pays for health, homeowners, auto, and life insurance policies |
| Range | 200-997 (LexisNexis Risk Classifier); 300-900 (TransUnion, FICO); 300-997 (ChoicePoint); 300-997 (Allstate's ISM7 Scorecard) |
| Good Score | 670 or above (general credit score); 770 or above (LexisNexis); 700 or above (FICO); 800 and above (excellent credit score) |
| Poor Score | Below 580 (general credit score); Below 500 (LexisNexis); Below 700 (FICO) |
| Use Cases | Homeowners and personal automobile insurance |
| Controversy | The use of insurance scores is controversial, with some states prohibiting or restricting their use. Critics argue it is unfair, has a disproportionate impact on minority communities, and penalizes consumers for factors unrelated to payment history. |
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What You'll Learn
Credit history and insurance scores
Credit-based insurance scores are used by insurers to determine an individual's insurance premiums. These scores are calculated using information from credit history and other factors such as payment history, outstanding debt, credit history length, pursuit of new credit, and credit mix. While it is not the same as a regular credit score, it is calculated using similar information.
Insurers consider an individual's credit history as an indicator of financial responsibility. Actuarial studies indicate that consumers with lower credit scores are more likely to file insurance claims, thus posing a greater financial risk for insurers. As a result, a poor insurance score often leads to higher insurance rates.
In the United States, the use of credit-based insurance scores to determine premiums is allowed in most states. However, some states, including California, Hawaii, Massachusetts, and Michigan, prohibit or restrict the use of these scores in calculating car insurance rates. Additionally, California, Massachusetts, and Maryland ban the use of credit information for setting home insurance rates.
It is important to note that insurance scores are not available to consumers, and the scoring systems vary between companies. Therefore, it is challenging to determine what constitutes a "good" or "bad" insurance score. Individuals can request their credit reports from credit bureaus to understand their credit history and identify any errors that may impact their insurance premiums.
While credit history plays a role in insurance scoring, it is not the sole factor. Other considerations include an individual's history of claims, driving record, and insurance history. These factors collectively contribute to determining insurance premiums.
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Actuarial studies and risk prediction
Actuarial studies suggest that an individual's financial management skills are a good indicator of how likely they are to file an insurance claim. As a result, insurance companies often analyse an applicant's credit history and insurance score to assess their financial responsibility. A lower credit score may indicate a higher likelihood of filing claims, thus increasing the financial risk for the insurer. This information is used to determine insurance rates, with those having lower scores typically charged higher premiums.
Actuarial risk assessment instruments (ARAIs) are commonly used in the insurance industry to predict the probability of future events. These instruments use statistical analysis to estimate the likelihood of an event occurring, such as an individual filing an insurance claim. The LexisNexis Risk Classifier, for example, assigns scores ranging from 200 to 997, with higher scores indicating lower risk. While these instruments can provide valuable insights, they may not always capture the full complexity of risk, sometimes ignoring factors such as the nature, severity, and frequency of potential losses.
Actuarial studies have also been applied to predict criminal recidivism risk, particularly for sex offenders and violent offenders. These studies use historical data and statistical models to estimate the likelihood of reoffending. While some studies suggest that actuarial assessments can accurately predict imminent and less severe reoffending, they may be less precise for repeated or violent offences. The predictive validity of these assessments can vary, and there is an ongoing debate between actuarial and clinical approaches to risk assessment in this context.
In conclusion, actuarial studies and risk predictions play a crucial role in the insurance industry, helping to determine insurance scores and rates. Actuarial risk assessments provide valuable insights into future events, such as insurance claims, by analysing historical data and statistical models. However, it is important to recognise the limitations of these predictions and consider the potential impact of other factors that may influence risk.
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Insurance pricing and scoring controversy
Insurance scores, also referred to as credit-based insurance scores, are ratings based on a consumer's credit information. Insurers use these scores to help underwrite and price policies. The use of insurance scores is, however, controversial.
The Controversy
The use of credit information in insurance pricing and underwriting is heavily disputed. Proponents of insurance credit scoring include insurance companies, the American Academy of Actuaries (AAA), the Insurance Information Institute (III), and credit bureaus such as Fair Isaac and TransUnion. Active opponents include many state insurance departments and regulators, and consumer protection organizations such as the Center for Economic Justice, the Consumer Federation of America, the National Consumer Law Center, and Texas Watch.
Actuarial studies indicate that consumers with lower credit scores may be more likely to file claims, thus posing a greater financial risk for insurers. Insurance companies, therefore, view an applicant's credit history as an indicator of financial responsibility. As a result, a poor insurance score typically results in higher rates.
While insurance scores are not available to consumers, it is generally understood that a good credit score is 670 or above, with scores above 800 considered excellent. If an individual's credit score is under 580, their credit could significantly raise the cost of coverage.
Legislative Action
The controversy surrounding the use of insurance scores has led to legislative action in some states. California, Hawaii, and Massachusetts have prohibited the use of insurance scores in pricing car insurance. Additionally, California, Massachusetts, and Maryland ban insurers from using credit information to set home insurance rates. Other states, such as Michigan, have placed restrictions on the use of credit information, requiring insurers to provide a disclosure statement when using insurance scores.
The National Association of Insurance Commissioners (NAIC) has acknowledged the correlation between insurance scores and losses but asserts that the benefit of credit reports to consumers has not been established. The Federal Trade Commission (FTC) has also noted that little data is available to evaluate the benefit of insurance scores to consumers.
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Improving a low insurance score
An insurance score is a rating used by insurance companies to determine the cost of insurance coverage. It is calculated using similar information to a credit score, such as debt, payment history, and borrowing habits. A low insurance score typically results in higher insurance rates, as it indicates a higher risk of filing claims.
To improve a low insurance score:
- Establish a credit history: A longer track record of responsible credit use can positively impact your score.
- Improve your credit score: Pay bills on time, keep credit utilization below 30%, and make a plan to pay down existing debt.
- Avoid hard credit checks: Recent credit applications can negatively impact your insurance score.
- Regularly review your credit report: You are entitled to one free annual credit report from Equifax, Experian, and TransUnion.
- Limit credit accounts and credit cards: Having too many credit accounts or cards in your name can negatively impact your score.
- Avoid "quick" credit fixes: Good credit is built over time, so avoid shortcuts that may seem too good to be true.
Improving your credit score and financial responsibility can lead to a higher insurance score, resulting in lower insurance rates and premiums. It's important to note that improving your insurance score takes time, but it is achievable through responsible financial behaviour.
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Insurance scoring models and their limitations
Insurance scoring models are built using selections of credit report factors, combined with insurance claim and profitability data, to produce numerical formulae or algorithms. These models are generally unique to each insurance company and line of business, with specific factors considered and weightings assigned. While insurance scores are confidential, they are based on similar credit information as a regular credit score, including financial habits and choices such as the age of the oldest account, the number of recent inquiries, and credit balances.
These scoring models are used by insurers to predict profitability and risk, with a strong relationship observed between credit-based insurance scores and profitability or risk of loss. They are particularly predictive when little to no other information is available, such as in the case of clean driving records or claims-free policies. However, it's important to note that insurance scores are not intended to measure creditworthiness directly. Instead, they focus on financial habits as predictors of insurance risk.
The use of insurance scoring models has sparked concerns about fairness and transparency, with critics arguing that most consumers don't fully understand credit-based insurance scoring or its implications. Additionally, there are worries about the unequal effects of these models on consumers from varying income levels and ethnic backgrounds. For instance, studies have shown that African Americans and Hispanics are overrepresented in the lowest credit score ranges, while Caucasians and Asians are more evenly distributed across the scores.
While insurance scoring models have their benefits in assessing risk, they are not without limitations. One significant limitation is their lack of availability to consumers, making it challenging for individuals to understand their standing and take corrective actions. Another limitation is the potential for discrepancies between different scoring systems used by various companies, leading to inconsistencies in insurance scoring across the industry.
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Frequently asked questions
An insurance score is a rating used by insurance companies to predict the probability of a client filing an insurance claim. It is based on a consumer's credit information and other factors like driving experience, previous claims, and financial habits.
A high insurance score indicates that an individual is less likely to file a claim, resulting in lower insurance premiums. Conversely, a low insurance score can lead to higher insurance premiums. The impact of insurance scores on premiums varies across insurance companies and types of insurance policies.
Improving your credit score, paying bills on time, and reducing debt can positively impact your insurance score. Additionally, shopping around for insurance providers and requesting your insurance score from them can help you obtain more favourable rates.
