November 9th, 2010
Insurance Scores: Believe it or not, your credit affects your insurance premiums
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Here is yet another item to add to the list of what is influenced by your credit health: your insurance.
How much you’ll pay for insurance premiums, as well as your access to homeowner and car insurance, is directly affected by your credit history.
It’s called your insurance score, and while many are unaware that insurance companies use your credit history when making insurance decisions, now is the time to start paying attention.
What is an insurance score?
Just like credit scoring models, insurance scoring models produce a unique numerical insurance score that insurers use to predict risk and calculate your premiums.
Similar to the way lenders use credit score models, insurance scores also 1) look at your credit history, 2) use a scoring formula based on aspects of your credit report and history, and 2) predicts the level of insurance risk you represent.
While insurance score models differ from company to company and state to state, your insurance score will affect whether you qualify for insurer’s underwriting programs and how much you will pay for insurance premiums.
The practice of using credit histories to set insurance rates has been around for 15 years. Some states, like California, don’t allow credit history to be used at all for insurance purposes. There is also an on-going debate in several states as to the legitimacy of using credit information to make insurance decisions, and whether credit history and responsibility can be positively linked.
What is the correlation between credit and insurance?
There is an assumed correlation between credit behavior and the likelihood of an insurance claim, of your credit history being a predictor of your future financial behavior. The basic assumption is that those with good credit are less likely to make a claim, suffer a loss, and cost insurers money than a poor credit consumer.
Your financial stability—based on factors like your payment history and debt level— suggests to insurers the level of your insurance risk. Insurers then calculate rates and premiums equal to your risk level. Technically called the “loss ratio relativity”, the model measures how much they stand to lose in claim money versus how much they stand to collect in premiums. If the model calculates that your insurance claims may be higher or lower than average, insurers price your premiums accordingly to make sure profit is still made.
As with most credit-related models, it is not an exact science. But if insurance companies are pricing your policy based on your credit, your wallet will suffer unless you build better credit.
I have poor credit… what do I do?
Those with less-than-perfect credit can look on the bright side: your insurance score isn’t the sole determinant of your insurance policy and rates. Non-credit factors such as your driving history, past accidents, where you live, and claims history are also considered.
However, now you have an additional reason to better your credit health. Bettering your chances of the best insurance policy and rates is the same true-and-tested strategies of building good credit. Your best bet is to improve your credit health and likewise perk up your insurance score.