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Buying Insurance? Your Credit Score Can Affect Your Rates

by Michael Bauch

A credit score is a number generated by a computer program based on information from credit bureaus, such as Equifax, Experian and TransUnion. Insurers say that scoring helps increase the accuracy of underwriting--examining, accepting, or rejecting insurance risks and classifying the ones that are accepted, in order to charge appropriate premiums.

Is there a connection between how a people conduct their financial affairs and the likelihood that they will file insurance claims? Insurance companies apparently think so, especially after Tillinghast, a well-known insurance consulting firm, found a 99 percent correlation between insurance scores and what companies pay in claims relative to the premiums they collect from policyholders.

Your "FICO" Score
Most life insurance and personal lines companies (home insurance, auto insurance) use a scoring model developed by Fair Isaac Corporation. The score derived from the model has been trademarked under the acronym "FICO." According to Fair Isaac, its FICO credit scoring models evaluate the following types of information:

  • Payment history (35 percent)
  • Amount of credit utilized (30 percent)
  • Length of credit history (15 percent)
  • Recent applications for credit (10 percent)
  • Number and types of credit accounts (10 percent)
Why Insurance Scores are Important to Insurers
Credit scoring is important to insurers for a variety of reasons, including:

Accuracy. Insurers are permitted to use only the information they need in order to make fair and impartial decisions about the type of risk they may be taking on. Credit scoring allows insurance companies assess the risk of a policy holder and group that policy holder with others in similar risk categories. Individuals with higher risks are considered more likely to file claims--ultimately costing the insurer money. Using credit scoring allows the insurer a greater degree of accuracy when underwriting new policies.

Faster processing time. The computerized processing of your risk information means that underwriting decisions can be made more quickly, which can help speed up decisions about policy approvals.

Why Credit Scores are Important to Consumers
Consumers should see some benefits as a result of more accurate and faster underwriting of life, auto, and home insurance policies. Benefits should appear in two forms--lower rates and more options.

Lower rates. With more accurate underwriting practices, insurers should be able to better control their losses. As a result, the overall rates of policies should come down as insurance companies can pass on the savings to the consumer.

Better selection. As computerized scoring can provide greater accuracy about the risk among various policyholder groups, insurers should be able to offer a wider selection of policies at different levels of risk.

As insurers collect more detailed information about your risk, they can better gauge how much to charge for their policies. In turn, because credit scoring can directly affect how much you pay for your insurance, you should be sure to keep your credit report in good standing--it could help you save in the long run.

Sources
Insurance Information Institute, Credit Scoring
InsuranceScore.com "How Credit Scoring Helps You," Get the Facts on Credit-Based Insurance Scoring
U.S. Department of Commerce, Minority Business Development Agency, "What is the FICO Score and What Factors are Considered?"

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