How Your Credit Score Affects Insurance Costs

With the recession of the past few years, many individuals’ credit scores have taken a hit. In addition to affecting your ability to get a mortgage, loan or credit card, your credit score can also affect how much you’ll pay for your insurance.

Credit scores range from a low of 330 to a high of 830. Today, the average American has a credit score of 687, reports Experian, one of the three major consumer credit reporting companies.

Credit-based insurance scores evolved from traditional credit scores, and insurance companies began to use them in the mid-1990s. NAIC, the National Association of Insurance Commissioners, says that insurers initially used credit-based insurance scores for underwriting, or to decide whether to offer or limit coverage to a particular applicant, it said. “Only in the last ten years have insurers decided to also use the scores for pricing.” Today, all major auto insurance companies use credit-based insurance scores in some capacity, reports the Federal Trade Commission.

Unlike lenders, insurers do not use credit-based insurance scores to predict payment behavior, such as whether you will pay your premiums on time. Rather, they use scores as a factor when estimating the number or total cost of insurance claims that prospective (or renewing) customers are likely to file.

Insurers say there is a correlation between credit information and a risk of loss — consumers with poor credit histories are more likely to file claims than those with good histories. Insurers assert that credit-based insurance scores help them evaluate risk more accurately, allowing them to charge premiums that conform more closely to the insurance risk a consumer actually poses.

Use of credit-based insurance scores has stirred up controversy from the start. When the Gramm Leach Bliley Financial Service Modernization Act allowed insurers to merge with banks and other organizations, some worried that insurers would have more access to consumers’ personal financial information. Credit-based scoring also can have a disparate impact on minorities, leading to charges of redlining. And because credit-based scoring formulas are proprietary, that only increases the suspicions of consumer advocates and some legislators. 

In fact, most states have taken some sort of action to govern insurers’ use of credit-based insurance rating. In 2002, the National Conference of Insurance Legislators (NCOIL) created a model law to encourage states that hadn’t already taken action to do so. To date, 26 states have adopted the NCOIL model act or portions of it.

The NCOIL model act:

• “Requires disclosure and use of updated, accurate credit data
• Bans consideration of certain personal information
• Mandates filing of scoring models
• Prohibits data selling, among other things.”

(Source: National Association of Insurance Commissioners, NAIC Credit Hearings)

More recently, the Great Recession, a string of natural disasters and their effects on credit scores prompted NCOIL to update its model. The changes encourage insurers to make allowances for changes in credit information due to “extraordinary life circumstances,” such as involuntary job loss; overseas military deployment; serious injury, illness or death of the consumer or immediate family member, divorce, and more.

Some states have taken further action. Massachusetts and California prohibit the use of credit-based scoring in auto insurance; Hawaii bars it for auto and home insurance. Michigan had a law banning the use of credit-based insurance scores, but the state’s Supreme Court overturned it. If you plan to apply for insurance, or if your rates are higher than you think they should be, check your credit report for accuracy. You can obtain a free copy of your reports from all three major credit bureaus (Equifax, TransUnion and Experian) once a year at www.annualcreditreport.com.

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How Your Credit Score Affects Insurance Costs