How Your Credit Affects Your Insurance

With mortgage rates at record lows, many people are scrambling to get their finances in order so that they can buy a house or refinance their current home loan. Now we all know that our credit histories will affect whether or not we get the loan we need to buy a house (or car, boat, etc.) or refinance an existing loan, but what most people don’t realize is that credit histories can also affect how much we pay for auto insurance. Not only can it affect our rates, but it may even impact whether we can get insurance at all, at least from some companies.

Increasingly, insurance companies are using credit reports to develop credit “scoring systems” that classify consumers based on several factors. As a consumer, how you’re classified – whether you fall into a preferred, average, or high-risk class – can impact what rate an insurance company charges you.

The use of credit scores in insurance rating became commonplace over a decade ago with homeowners insurance. It grew out of companies’ attempts to create rating plans that would assess risk levels as accurately as possible, in order to predict their own expenses as well as charge appropriate rates. Banks and other financial institutions had long used credit information in determining risk on business such as home loans, and the correlation between those financial records and insurance risks became clear.

The trend moved into the auto insurance industry, and as soon as the math was done, insurers realized they were onto something.

“After all the variations in rating plans had been accounted for, there was still something statistically significant that was explained by credit rating scores,” said Wayne Holdredge, a senior partner with the insurance consulting firm Tillinghast-Towers Perrin. “Within the last few years, virtually every company is doing it, because if you don’t, you get what’s left over – the people who have low credit.”

Holdredge has studied the issue for years, and said the numbers don’t lie – higher credit scores translate statistically into better insurance risks. The wisdom is that, just as people with good driving records expect good rates, high credit scorers can therefore pay rates that reflect that.

The laws that govern insurance companies and regulations are set at the state level, so where you live determines what information companies can gather and how they can use it, as well as what your rights are. Generally, in states where it’s allowed, insurance companies use your credit information like this: They plug basic credit information (such as bankruptcies, missed payments, the number of cards you have and how much activity they see) into formulas that also take into account your accident history, years you have been driving, geographical factors where you live, your age, gender and assorted other relevant facts about you.

The formulas assign varying levels of importance to these based on rather complex data such as the company’s loss history and how statistically important the factors have been shown to be for that company. (For example, males are more likely than females to get into accidents. How much more likely depends on still other criteria, such as what kind of cars they drive.) From a mathematical maze of interlocking facts and levels of importance comes a risk level – and a rate plan – for each insurance consumer.

Many states are required to tell consumers what the top several factors are that affect their rates, but your insurer may not even understand the exact significance of some of the numbers, since they often come from outside sources. If you’re interested in finding out if credit was used to determine your rates, contact your insurance carrier.

“The best advice for everyone is that periodically you need to get your credit checked,” Holdredge said. That way, if you spot something, you can take steps to fix it before it hurts you.

So, what if you’re insured, and your credit takes a turn for the worse? You’ll probably be all right. For one thing, companies who know and trust you may be reluctant to (or may not be allowed to) raise your rates for no other reason than a credit score. And credit scores generally don’t vary dramatically over short periods of time.

Also, insurance companies fall into one of two camps: those that use credit in rating only new business, and those that favor using credit scores in periodic updates and adjustments. Consumers may be relieved to hear that Holdredge estimates 80 percent of companies fall into the “new business only” category.

Holdrege also sees positive aspects to the use of credit in insurance. “It allows companies to write risks they otherwise would not have in the past,” he said. “It allows them to go into areas they were hesitating to appeal to.”

For example, in an area that has been deemed geographically undesirable (such as large cities due to heavy traffic and density, high incidence of car theft, and vandalism) a resident with a high credit score may find coverage more easily than would have been the case without factoring in credit.

Whether or not you support the use of credit in insurance rating plans, it’s wise to regularly review your credit report. And know your rights – Under the Fair Credit Reporting Act (FCRA), consumers have the legal right to obtain a free credit report if an “adverse action” has been taken as a result of a credit report or score. (The act was passed to hold credit reporting agencies accountable to standards of confidentiality, accuracy and proper use of credit information. For more information on your rights under FCRA, go to www.ftc.gov/os/statutes/fcra.)