Credit-Based Insurance Scores
Most insurance companies nowadays are using insurance scores in those states that allow it, in addition to other factors, to determine the premiums to charge customers for auto and home insurance, or whether to insure them at all. For instance, according to the Consumer Data Industry Association (CDIA), which represents more than 400 consumer data companies, 92% of the largest auto insurers use credit data for evaluating new potential customers, and half started doing so after 1998.
A credit-based insurance score is a 3 digit number resulting from a statistical analysis of a consumer's credit record that is highly predictive of future claim costs. Several studies by actuarial groups, notably Tillinghast Towers-Perrin and the Casualty Actuarial Society, have found, with a statistical correlation greater than 99%, that the loss ratio, which is the ratio of losses and associated expenses to premiums, is significantly higher for people with lower scores. In fact, for those with the lowest credit scores, the loss ratio actually exceeds 1, where losses exceed the premiums collected. A recent study by the Texas Department of Insurance showed that the loss ratio for homeowners with the worst scores was triple that of those with the highest scores and drivers with the highest scores had 40% fewer accidents over those with the worst scores. The insurance industry also believes that credit reports are more accurate than motor vehicle registration records for predicting future auto accident claims.
According to 1 study, the Consumer Federation of America found that Allstate charged 39% more for drivers with top insurance scores over others with poor scores; State Farm's prices varied even more – 127%.
There are different insurance scores available, but not all of them are available to the consumer. Probably the insurance score that is used most by insurers is by FICO, who also provides the most common credit scores for lenders. The main company providing insurance scores is Fair Isaac Corporation (now calling itself FICO), which sells the scores to the 3 main credit reporting agencies—Experian, TransUnion, Equifax. Fair Isaac also supplies the FICO credit score, which is the most popular credit score used by lenders. According to Fair Isaac, 90% of the top property and casualty insurers and 300 others use insurance scores for rating and underwriting.
Tips and Resources for Improving Your Credit Score or Insurance Score
- Get a free credit report at AnnualCreditReport.com every 4 months by requesting a report from only 1 credit reporting agency at a time—a good, free way to monitor your credit report.
- Some credit cards offer free credit scores that are updated at least monthly. For instance, Discover Card provides a free FICO score based on your credit information held by TransUnion. Even if the credit card does not provide a FICO score, any score can be used to monitor changes in your credit information by checking for monthly changes in your score. Credit scores often change by 10 to 20 points during the month, but if you notice larger changes in your score during a time when there was no significant credit event, you may want to check the credit report from the agency on which the score is based for errors or for possible identity theft.
- As of November, 2015, you can upload supporting documents, such as paid bills or canceled checks, to support your credit dispute. Source: Fixing Credit Report Errors Online Gets Added Heft - The New York Times
- File a credit reporting complaint with the Consumer Financial Protection Bureau.
- Sample Letter for Disputing Errors on Your Credit Report with Information Providers. See also Disputing Errors on Credit Reports by the FTC.
- If you want to send a letter to the CRAs that may lead to legal action, then send it as certified mail with return receipt.
Although the algorithm used to compute the scores is the mostly the same, insurance scores, like the FICO and other scores that are based on credit information, will probably differ to some extent from each of the credit reporting agencies, since the information that each agency has on each consumer differs to some extent. However, the algorithm for computing insurance scores does different to some extent to conform to state law.
Although insurance scores are calculated using the information in the consumer's credit file, only some of the information is used and it is weighted differently than the information used in calculating credit scores. There is a greater weight given to payment history and total debt and less for types of credit used or the number of inquiries made for loans and credit, for instance.
Many states have limited the use of insurance scores for rating and underwriting. Montana, New Mexico, and Washington have recently enacted legislation that restricts the use of insurance scores in rating and underwriting consumers. Washington state law forbids companies to deny insurance or base rates on the lack of credit history, available credit, number of credit inquiries, collection accounts for unpaid medical bills, and using a particular type of credit. Kansas has similar laws. Maryland banned the use of insurance scores for determining premiums for homeowner's insurance in 2002. Texas law prohibits the absence of credit information to be used in underwriting decisions, and insurers must account for extraordinary circumstances, such as hospitalization or identity theft, that could cause declines in one's insurance score if the insured requests special consideration in writing. Michigan requires insurance companies to recalculate the score annually, and also when consumers successfully correct information in their credit records. However, only 3 states — California, Hawaii and Massachusetts — prohibit the use of insurance scores altogether.
In response to criticism about using insurance scores for rating consumers, insurance companies have argued that:
- there is a high correlation between low credit ratings and future claims;
- people who are responsible with money are generally more responsible in other areas of life, such as driving and preventing hazards at home;
- using insurance scores is more objective and less discriminatory, and most consumers will pay less since most people have fairly good credit;
- and that the Fair Credit Reporting Act allows them to use credit information for rating and underwriting.
Insurance companies have also argued, in opposing changes to regulations in Michigan, that eliminating the use of insurance scores will increase prices for most consumers:
- Auto Club Insurance Association (AAA) claims that 2/3 of its policyholders will see rate increases if insurance scoring is eliminated.
- Hastings Mutual has a 5 tier discount level for premiums that range from 0 to 35% for auto insurance and 0 to 27% for homeowner's insurance. Hastings Mutual claims that 77.6% of its auto customers and 84.4% of its homeowners will see rate increases if the use of insurance scores are banned.
People opposing the use of insurance scores have argued that:
- it discriminates against ethnic groups or economically disadvantaged people, such as single mothers;
- credit reports often contain errors that would increase premiums for people who would otherwise qualify for lower premiums;
- and insurance scores are socially unacceptable.
Legal Basis for Using Credit Information for Insurance Purposes — Excerpt from the Fair Credit Reporting Act
15 U.S.C. §1681b, 604. Permissible purposes of consumer reports
(a) ... any consumer reporting agency may furnish a consumer report under the following circumstances and no other: ...
(3) To a person which it has reason to believe
(A) intends to use the information in connection with a credit transaction involving the consumer on whom the information is to be furnished and involving the extension of credit to, or review or collection of an account of, the consumer; or
(B) intends to use the information for employment purposes; or
(C) intends to use the information in connection with the underwriting of insurance involving the consumer;