Anyone that's recently applied for a homeowners or car insurance policy may be familiar with insurance credit ratings. These ratings are based on the policyholder's credit score, and are oftentimes used by insurance companies to determine policy premiums.
In this article, we're going to explain why insurance companies are now taking a closer look at an applicant's credit score. We're also going to explain how these companies can use the information found in a credit report to determine the premiums charged on a policy. Then we'll finish up by explaining what consumers can do to improve their scores.
Both federal and state law allow insurance companies to look at an applicant's credit information, without their knowledge, as provided under the rules of the Fair Credit Reporting Act. Because the law only allows credit reporting agencies to use certain information in calculating a consumer's rating, the industry has developed what is called an insurance credit score.
Typical inputs to this score would include monthly bill payment patterns, the total number of credit cards and / or loans outstanding, collection activity, total outstanding debt, and the amount of history on an account.
Agencies use the above information to calculate a credit score, which is a numerical value that insurance companies then use to help them determine the monthly or annual premiums to charge a customer. They have started to do this because they believe there is a direct relationship between a consumer's payment history, or financial dependability, and insurance losses.
For example, an individual or family that demonstrates less financial dependability may be more likely to file an insurance claim. For this reason, this individual or family should also pay higher premiums on their insurance policy.
Under the law, insurance companies cannot increase an insurance premium if a policyholder does not have sufficient payment history to calculate a score. When a score can be calculated, insurance companies may use this information in the following ways:
Each agency will have a slightly different approach to calculating an insurance credit score; however, the elements that go into the score will be similar. Typically, these factors will include:
It's very difficult to answer the question: What is a good insurance credit score? Each insurance company is free to choose what they believe is, or is not, a good score. Different companies may view the same score in a slightly different way, or apply a slightly different policy premium.
Starting in January of 2003, consumers were offered some protections in terms of how insurance companies could use credit information. This includes data that cannot be used in a score's calculation, such as:
This kind of information cannot be used to cancel, or non-renew, an existing insurance policy or deny coverage to a family or individual.
Scores are just one of several factors used by companies to determine policy premiums. Insurance companies calculate their premiums based on factors such as the cost to replace a home or car, where the home is located, policy deductibles, and the breadth and depth of insurance provided by a policy. For example, if the policyholder elects to increase their liability insurance, that drives up the cost of the policy. If the policyholder elects to increase their plan deductibles, this will lower their cost.
Let's finish this article by addressing one last question: How can I improve my insurance credit score?
The most efficient way to improve a score is to find out what factors the insurance carrier uses to calculate their score. Most credit reporting agencies, such as Fair Isaac (which developed the FICO score), and Choice Point will provide insurance companies with up to four factors, each of which can have a positive or negative affect on a score.
Consumers can ask their insurance agent, or call their insurance provider directly. They should be able to provide guidance on the exact factors used to calculate their score. Anyone that believes there are errors in their credit history file needs to repair this damage. In our article on the Fair Credit and Reporting Act, we outline the exact steps a consumer can take to get their credit report corrected.
About the Author - Credit Scores and Insurance Premiums (Last Reviewed on May 31, 2016)