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 premiums charged to 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 exceeding 99%, that the loss ratio, 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 loss ratios for homeowners with the worst scores was triple 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 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 poor insurance scores over others with top scores; State Farm's prices varied even more — 127%.
Different insurance scores are available, but not all of them to the consumer. The main company providing insurance scores is FICO (formerly, Fair Isaac Corporation), which sells the scores to the 3 main credit reporting agencies (CRAs) — Experian, TransUnion, Equifax. FICO also supplies the FICO credit score, the most popular credit score used by lenders. According to FICO, 90% of the top property and casualty insurers and 300 others use insurance scores for rating and underwriting.
Although the algorithms used to compute scores is similar, insurance scores, like the FICO and other scores based on credit information, will differ somewhat from each of the CRAs, since the information held by each agency on each consumer differs slightly. Algorithms also differ to conform to state insurance 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 from credit score calculations. Greater weight is 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.
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.
- Many credit cards offer free credit scores, updated 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 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.
- Dispute any errors on your credit report with the CRA that compiled the information.
- Sample Letter for Disputing Errors on Your Credit Report with Information Providers. See also Disputing Errors on Credit Reports by the FTC.
- 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.
- To send a letter to the CRAs that may lead to legal action, send it as certified mail with return receipt.
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 argue that:
- low credit ratings and future claims are highly correlated;
- people responsible with money are generally more responsible in other areas of life, such as driving and preventing hazards at home;
- insurance scores are more objective, thus less discriminatory, and most consumers will pay less since most people have fairly good credit;
- 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 higher rates if the use of insurance scores is 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 may contain errors that would increase premiums for people who would otherwise qualify for lower premiums;
- 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;